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Board, audit
Board, audit committee, culture committee,
and earnings management: culture
Malaysian evidence
783
Rashidah Abdul Rahman
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Abstract
Purpose – Aims to investigate the extent of the effectiveness of monitoring functions of board of
directors, audit committee and concentrated ownership in reducing earnings management among
97 firms listed on the Main Board of Bursa Malaysia over the period 2002-2003.
Design/methodology/approach – The current study employs the cross-sectional modified version
of Jones, where abnormal working capital accruals are used as proxy for earnings management.
Findings – The study reveals that earnings management is positively related to the size of the board
of directors. This supports the view that larger boards appear to be ineffective in their oversight duties
relative to smaller boards. A possible explanation for the insignificant relationship between other
corporate governance mechanisms (independence of board and audit committee) and earnings
management is that the board of directors is seen as ineffective in discharging their monitoring duties
due to management dominance over board matters. The apparent reason for this phenomenon is
attributed to the board of directors’ relative lack of knowledge in company’s affairs. The study also
found that ethnicity (race) has no effect in mitigating earnings management, possibly due to the more
individualistic behaviour of the Bumiputra directors. The modernisation of Malaysia and also the
increase in Bumiputra ownership of national wealth may have caused the Malays to be more
individualistic, similar to their Chinese counterpart.
Originality/value – Since, there are relatively few studies conducted in this area specifically among
Malaysian firms, this study will broaden the scope by providing empirical evidence of the relationship
between various corporate governance characteristics, cultural factors and earnings management.
Keywords Earnings, Boards of directors, Audit committees, Culture, Malaysia
Paper type Research paper
Introduction
Based on agency theory, issues associated with the separation between ownership and
control will lead managers (agents) to act in an opportunistic manner by increasing
their personal wealth at the expense of the owners (principal) of an organisation (Jensen
and Meckling, 1976). As financial statements provide value-relevant information to the
external parties of the organisation, the heavy reliance placed on accounting numbers
create powerful incentives for managers to manipulate earnings to their own
advantage. The incentives for managers to manipulate reported earnings may be
influenced by job security, contractual agreements between managers and the external
stakeholders, self-interest in the presence of compensation schemes or the need to Managerial Auditing Journal
Vol. 21 No. 7, 2006
achieve target earnings and to meet market expectations (Healy and Wahlen, 1999). pp. 783-804
As such, earnings management, even if it is being done not in violation of the q Emerald Group Publishing Limited
0268-6902
accounting standards, may lead to inaccurate information about the company. Hence, it DOI 10.1108/02686900610680549
MAJ is crucial for an organisation to have an effective corporate governance mechanism to
21,7 safeguard the rights of the investors in getting the true and fair information of the
company.
The 1997 economic crisis in Malaysia has exposed serious weaknesses in corporate
governance practices namely, weak financial structure, over-leveraging by companies,
lack of transparency, disclosure and accountability. The introduction of the Malaysian
784 Code of Corporate Governance (2000) and the Bursa Malaysia Revamped Listing
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relevant literature on issues pertaining to earnings management and the role of board
monitoring together with cultural factors, which lead to the development of
hypotheses. The third section explains the research method followed by a discussion
of the results in section four. The paper ends with a summary and the conclusion of the
research.
Nevertheless, there has been considerable pressure on firms to increase the number
of non-executive directors on the board in the UK and USA (Davies, 2000). Similarly, all
public listed companies in Malaysia must ensure that at least one-third of their board of
directors consists of independent non-executive directors, thus enhancing the board’s
independence of the management (Bursa Malaysia Revamped Listing Requirement,
2001).
Several studies present evidence suggesting that effective governance with board
independence improve firm performance (Agrawal and Knoeber, 1996; Baysinger and
Butler, 1985), while the dominance of non-executive directors (in terms of numbers)
could provide them with more power to force management to improve the quality of
firm disclosure (Haniffa and Cooke, 2002). Unlike a Canadian study by Park and Shin
(2003) who found no significant difference between discretionary accruals (DAC) and
board composition, studies by Beasley (1996) and Klein (2002) found otherwise. Their
studies suggested that having outside independent directors on the board provide
added value to the board monitoring process. Beasley (1996) found a significant
negative relationship between outside directors and the occurrence of fraudulent
financial statements, whilst Klein (2002), Xie et al. (2003) and Peasnell et al. (2001)
found that outside directors are negatively associated with DAC. Peasnell et al. (2001)
suggested that the board balance between executive and non-executive directors
contributes towards the integrity of financial statements.
Hence, previous empirical findings seem to suggest that boards which are
structured to be more independent of the management are effective in monitoring the
corporate financial accounting process, thus leading us to the following hypothesis:
H1. There is a significant negative relationship between discretionary accruals
(DAC) and the proportion of independent directors on the board.
In addition, independent directors who had served the board for a certain period may
develop better governance competencies as well as provide additional knowledge and
expertise to the firm, thus are capable of monitoring management performance. For
example, Peasnell et al. (2001) found the average tenure of non-executive directors on
the board is negatively associated with the level of earnings management. Experience
as board members of the firm allows outside directors to gain a better understanding of
the firm and its people, thus enabling them to develop better governance competencies.
This leads to the following hypothesis:
H2. There is a significant negative relationship between discretionary accruals
(DAC) and the competence of independent directors on the board.
Further, the Malaysian code recommends that the role of the chairman be separated
from that of the CEO. This is to ensure that the CEO would not be in a position with too
much power to handle daily business operations. Proponents of the agency theory also
argue for the separation of these two roles. The chairman, they argue should be Board, audit
independent of company’s affairs while being on the board and in so doing will be a committee,
useful check on the over-ambitious plans of the CEO (Blackburn, 1994). Proponents of
the stewardship theory, on the other hand, argue that this role duality (where a CEO is culture
also the chairman of the firm) will improve firm performance because the
management’s compensation is tied to the firm performance, and that the CEO’s
strategic vision can shape the destiny of the firm with minimum board interference 787
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Audit committee
Malaysian public listed companies have been required by Bursa Malaysia (previously
known as Kuala Lumpur Stock Exchange) to establish an audit committee since
1 August 1994. In addition, the code specifies that an audit committee should comprise
at least three directors, the majority of whom are independent, while its chairman
should be an independent non-executive director. The establishment of the audit
committee is to ensure continuous communication between external auditors and the
board, where the committee meets regularly with the auditors to review financial
statements and audit processes and also internal accounting systems and control.
A study by Muhamad Sori et al. (2001) found that the Malaysian audit committee
chairman perceives that the committee plays an effective role in monitoring audit and
financial functions.
Vicknair et al. (1993) stated that in order to function effectively, audit committees
must be independent of the management as it allows both the internal and external
MAJ auditors to remain free of undue influences and interferences from corporate
21,7 executives. Peasnell et al. (2001) did not find sufficient evidence on the effectiveness of
the audit committee in reducing the level of earnings management. However, other
empirical studies generally show that the independence of the audit committee has
been found to be not only negatively associated with the occurrence of financial fraud
(Beasley, 1996; Dechow et al., 1995), DAC (Xie et al., 2003), and being sanctioned for
788 fraudulent or misleading reporting (Abbot and Parker, 2000), but are also positively
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related to financial reporting (Felo et al., 2003). Similarly, Choi et al. (2004) found that
when members of the audit committee hold shares in a company, they have less
incentive to deter earnings management. Thus, independence of the audit committee is
arguably a key factor in enhancing their role in preventing misstatements in the
financial statements. Hence, the next hypothesis is as follows:
H5. There is a significant negative relationship between discretionary accruals
(DAC) and the proportion of independent directors on the audit committee.
In addition, the need to have competent and experienced directors, particularly in
financial aspects, is equally important to audit committee members since the primary
function of an audit committee is to monitor the financial reporting process of an
organisation. Xie et al. (2003) and Choi et al. (2004) reported that outside directors who
are financially competent, are effective as monitors in reducing earnings management
behaviour. Further, Felo et al. (2003) found the percentage of audit committee members
having expertise in accounting or financial management is positively related to the
quality of financial reporting. The Bursa Malaysia listing requirements stipulates
among others, that at least a member of the audit committee must possess relevant
skills, experience and qualified knowledge, such as being a member of the Malaysian
Institute of Accountants. Hence, an audit committee that has knowledge and skills in
financial reporting is more likely to uncover opportunistic earnings management
activity by the management:
H6. There is a significant negative relationship between discretionary accruals
(DAC) and the competence of members of the audit committee.
Further, an audit committee that is independent and competent will play a more active,
effective and efficient monitoring role. Xie et al. (2003) reported that the number of
board meetings is negatively associated with the level of earnings management,
indicating that the board that meets regularly could be better monitors. This may stem
from the notion that an active board that devotes time to rectifying any immediate
issues may deter earnings management. As such, the following hypothesis is
developed:
H7. There is a significant negative relationship between discretionary accruals
(DAC) and the frequency of meetings of audit committee.
Concentrated ownership
Unlike in the UK and the USA which have a dispersed shareholder base, ownership
and control in Malaysian public listed corporations tend to be much more concentrated,
with shares often being owned by identifiable and cohesive groups of “insiders” who
have longer term stable relationships with the company. They may be members of the
company’s founding families or a small group of shareholders, such as lending banks,
other companies (through cross shareholdings and pyramidal ownership structures) or Board, audit
the government (Claessens et al., 2000). Past studies have shown that concentrated or committee,
block ownership can assist the board in increasing its monitoring effectiveness
(Shleifer and Vishny, 1997) and in terminating top executives in poor performing firms culture
(Denis et al., 1997). With regard to earnings management, Chtourou et al. (2001) found
that firms with low-level DAC have a larger percentage of shares owned by
blockholders. Thus, the presence of shareholders owning a large block of shares in a 789
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Cultural characteristics
Accounting research has for many years focussed on the influence of cultural values on
the development of accounting practices. Past studies have provided evidence on the
following: that accounting practices and disclosure are a function of the nation’s
cultural values (Perera, 1989; Mohd Iskandar and Pourjalali, 2000); that cultural
heritage affects attitudes towards business related fraud (Watson, 2003); and that an
organisation’s culture can predispose a company into considering fraudulent financial
reporting (Geriesh, 2003). Hofstede (1991) defines culture as the “collective
programming of the mind which distinguishes the members of one group or
category of people from another”. Among the components of national culture are the
prevalent value systems that are transferred from generation to generation. Values
refer to the broad preferences for one state of affairs over others. They are the acquired
knowledge that people use to interpret experiences; direct feelings of good and evil, and
affect perceptions of how things are, that eventually affect behaviour (Hofstede, 1991).
Chuah (1995) argues that the mind of Malaysian managers is influenced by race,
education and the type of organisation they work for. Using Hofstede’s (1983) four
dimensions (individualism, power distance, uncertainty avoidance, and masculinity) in
underlying the differences in the nation’s cultural values, Abdullah (1992) provides
evidence that the Malays are rated lower on individualism, which is partly attributed to
the fact that Islam emphasises groups and societies rather than individuals (Baydoun
and Willet, 1995). In addition, the concept of zakat (tax) in Islam promotes the
development of collectivism in the community by providing a mechanism for the rich
to help the poor. Using race and education as surrogate for culture, Haniffa and Cooke
(2002) found the Chinese to be more individualistic and more secretive in their
disclosure partly due to their entrepreneurial skills that have a greater influence on the
Malaysian economy. They, however, found Malaysian firms dominated by Malay
directors have a higher level of voluntary disclosure, which is consistent with the
Islamic business ethics that encourages transparency in business, thus may have fewer
tendencies to manage earnings. As such, the presence of Malay directors on the
board of a company and on audit committees may deter opportunistic earnings
management:
H9. There is a significant negative relationship between discretionary accruals
(DAC) and the proportion of Malay directors on the board.
MAJ H10. There is a significant negative relationship between discretionary accruals
21,7 (DAC) and the proportion of Malay directors on the audit committee.
Research design
The study examines 100 top companies listed on Bursa Malaysia Main Board,
790 ranked by Market Capitalisation at 31 December 2001 (Investors Digest, 2002)
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January, for the period January 2002 to December 2003. A final sample comprising
of 97 top companies for both years is selected from the list after excluding several
companies that did not meet certain criteria in the study. For example, companies
in the finance sector are excluded in the study since these companies come
separately under the Banking and Financial Institutions Act of 1989. Moreover,
they posses a unique and different working capital structure (Klein, 2002). In
addition, utilities companies are also excluded because they are very much
regulated by the government and acquire different incentives and opportunities to
manage earnings (Peasnell et al., 2001). Companies that do not have complete
financial data, complete information on directors or whose annual reports are
unavailable are also excluded.
Data relating to the board of directors and the audit committee attributes are
gathered using the company’s annual report as disclosed on the Bursa Malaysia
web site. Financial data are obtained from the Datastream. Any missing financial
figures from Datastream are acquired from the annual report.
net receivables for company i in year t less net receivables in year t 2 1; DREVi;t ;
revenues for company i in year t less revenues in year t 2 1; TAi;t21 ; total assets for
company i at the end of year t 2 1; a and b are industry-specific parameters.
The change in receivables is subtracted from the change in revenues to reflect the
fact that the change in receivables is treated as discretionary. Estimates of the
industry-specific parameters a and b are obtained by using the following OLS
regression model as illustrated in equation (2), in the estimation period. Equation (2)
use data from all companies matched on the year of observation and are categorised in
the same industry groupings. All variables in the regression model are deflated by
lagged total assets to reduce heteroscedasticity problems (Teoh et al., 1998; Abdul
Rahman and Abu Bakar, 2004; Abdul Rahman and Wan Abdullah, 2005).
WCAj;t =TAj;t21 ¼ a1 ð1=TAj;t21 Þ þ b1 ðDREVj;t =TAj;t21 Þ þ 1t ð2Þ
where WCAj;t ; working capital accruals in year t for industry j; defined as change in
non-cash current assets minus the change in current liabilities, a1and b1, denote the
OLS estimates of a and b in equation (1) above, 1t ; the regression residuals.
In essence, the working capital accruals are regressed on the change in revenue
since the underlying assumption under this model is that revenue is a component of
non-DAC. Equation (2) is estimated separately each year for all firms listed on
Datastream that are in the same industry category. Consistent with Klein (2002),
industries with less than eight observations are excluded in the analysis. The
regression coefficients in equation (2) (i.e.a1and b1) represent the parameter of interest
in estimating changes in non-DAC.
The discretionary working capital accruals (DAC) is then defined as the remaining
portion of the working capital accruals:
DACi;t ¼ WCð1=Ai;t Þ 2 NDACi;t ð3Þ
where DACi,t, discretionary accruals for firm i in year t; WC, working capital; NDAC,
non-DAC for firm i in year t.
Measurement procedure
The variables and their measurements used in this study are summarised in Table I.
Consistent with Klein (2002), Becker et al. (1998) and Warfield et al. (1995), the study
incorporates absolute value of DAC as the dependent variable. The direction of
earnings management is disregarded to include the combined effect of income
increasing and income decreasing earnings management.
The variables for board of directors and audit committee are measured at the
beginning of the year in which earnings management occurs. Four variables that
represent board of directors’ attributes are the proportion of independent directors,
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21,7
792
MAJ
Table I.
variables
Summary of the
operationalisation of
Variables Measurement scale
Similar to Chtourou et al. (2001) and Peasnell et al. (2001), competence of the board is
measured using the average tenure of the independent non-executive directors (the
total number of years of service divided by the number of independent non-executive
directors in a company). CEO duality is the separation of the role of chairman and CEO,
where firms that combined the title are labelled “1” and firms that separated the title
are labelled “0”. Board size refers to the total number of board members, similar to that
employed by Xie et al. (2003) and Peasnell et al. (2001).
Similar to the studies conducted by Chtourou et al. (2001) and Abdul Rahman and
Haniffa (2003), concentrated ownership is based on the percentage shareholding of the
combined number of significant shareholders in a company. Three variables that
exemplify the audit committee characteristics are the proportion of independent
directors, competence and the activity of the audit committee. As summarised in
Table I, the proportion of independent non-executive directors in the audit committee is
calculated by dividing the total number of independent non-executive directors in the
audit committee by the total number of audit committee members. The competence of
an audit committee is measured based on the accounting qualification of the members
of the committee (Choi et al., 2004) taking the value of 1, if at least one member of the
committee is a qualified accountant and 0 otherwise. Similar to Choi et al. (2004), the
study also incorporates the frequency of meetings to gauge the audit committee’s
activity.
The measurement of race as surrogate for culture in this study is acknowledged to
be biased but the effect of race may be significant in a multiethnic society like Malaysia
where each group maintains and practices its own cultural values and religious beliefs.
The ethnic composition of directors on board is measured as the ratio of Bumiputra
directors to the total number of directors on board, whilst the ethnic composition of the
audit committee is the ratio of Bumiputra directors to the total number of directors on
the audit committee.
Factors other than corporate governance practices and cultural factors may also
contribute to the reduction of earnings management. The study uses six control
variables: ROA, leverage, cash flow, size, book to market value ratio and Big5 auditors,
as summarised in Table I. Bartov et al. (2000) reported that firms experiencing financial
difficulties (proxy by book to market ratios and financial leverage) as well as low firm
performance (ROA and cash flow) have more incentive to engage in earnings
management activity. This is because, higher leverage and lower firm performance
means higher bankruptcy risk, which in turn will lead to litigation risks. Past studies
have also shown that companies employing Big5 auditors reported lower levels of DAC
than companies employing non-Big5 auditors (Becker et al. 1998). In comparison to low
quality auditors, high quality auditors such as Big5 auditors are more likely to detect
questionable accounting practices and to a certain extent may compel management to
follow accounting practices as prescribed by the accounting standards.
MAJ In addition, the log of book value of total assets is used as a proxy for size because
21,7 smaller firms are less scrutinised by authorities and is therefore more inclined to
manage earnings (Xie et al., 2003). Becker et al. (1998) and Dechow et al. (1995) reported
a significant negative association between DAC and cash flow. This is particularly so
in the event where companies are close to debt covenant restrictions, quite often the
level of cash flow is also low. Hence, managers are more inclined to manage earnings
794 upwards.
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Findings
Descriptive statistics
The descriptive statistics of the DAC and the continuous independent variables used in
the sample are shown in Tables II and III. As shown in Table II, the magnitude of
absolute value of DAC of the companies in the sample has a small mean value of 0.04
whereas the minimum value is very much closer to 0 (0.0001). These findings are
consistent with Klein (2002) where a minimum value of absolute DAC among large US
firms was 0.00002. However, the average absolute DAC among US companies is 0.11.
Based on the one sample T-test, the p-value for absolute values of DAC is significantly
different from 0 at 1 per cent significant level. As such, the test provides evidence that
on average, large Malaysian public corporations manage their reported earnings.
As in Table III, 90 per cent of audit committees in the study meet the Bursa
Malaysia Listing Requirement of having at least one qualified accountant as a member
of the audit committee.
Table III also shows that 81 per cent of the sample firms employ Big5 audit firms as
opposed to only 19 per cent of the companies employing non-Big5 public accounting
firms as their auditors. This is due to the complex and sophisticated nature of activities
of large companies. In addition, proficient and competent auditors will raise the
investors’ perception of the credibility of the audited financial statements.
A correlation coefficient analysis is further performed to examine the relationship
between the dependent and independent variables. This test examines the extent to
which both dependent and each independent variable in the study are related. Prior to
conducting the correlation analysis, the variables are analysed for their distribution. The
purpose of the normality test is to determine the correct type of statistical analysis to be
employed in further examining the relationship of the variables. In order to conduct
Pearson correlation analysis, both dependent and independent variables must be
normally distributed continuous variables (Keller and Warrack, 2003). The data are said
to be normal if the standard skewness is within ^ 1.96 and standard kurtosis of ^ 2.
Variables that are not normally distributed, as shown in Table II, are transformed
using normal scores to fulfil the assumption of normality (different transformations
using rank and log were undertaken but transformations using normal scores produce
better estimation and have more advantages than the others). The main advantage of
using normal scores transformation is that the exact statistical properties can be
determined (Haniffa and Cooke, 2002). Both the F- and T-tests and the regression
coefficients derived using this transformation gave more meaningful interpretations.
It also offers a means of transforming a non-normal dependent variable into normality
thus implying that errors are normally distributed by the assumptions of OLS. It also
preserves monotonicity in relationships with higher ranked values of the independent
variables being associated with higher ranked values of the dependent variables (the
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variables
Descriptive statistics of
committee,
Board, audit
795
Table II.
MAJ converse is also true). In addition, when there is non-linearity with data concentration,
21,7 this transformation disperses the concentration.
As illustrated in Table IV, all corporate governance and cultural variables are not
significantly related to earnings management. Notwithstanding this, there are a few
observations that require further elaboration. For instance, the coefficient of correlation
between board size and DAC is positive. This indicates that as the size of the board of
796 directors increases, the level of earnings management also increases. In addition, the
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results of x 2-test also provide no significant relationship between DAC and the two
variables, duality role and the competence of audit committee.
The correlation matrix in Table IV confirms that there is no multicollinearity among
variables since none of the variables correlates above 0.8 or 0.9. In addition, there is no
predictor variable that produces a variance inflation factor greater than 10, confirming
that collinearity is not a problem in this study.
Multivariate analysis
As an extension of the correlation analysis performed earlier, a multiple regression
analysis is employed to gauge the explanatory power of the independent variables
against DAC.
Based on the statistical analysis shown in Table V, the adjusted R 2 value for the
model is 12.8 per cent. The low value of adjusted R 2 in this study indicates that there
are other factors that strongly explain the variation in the level of earnings
management. Contrary to the first hypothesis that states there is a negative
relationship between DAC and the proportion of independent directors, the result
indicates that there is no significant relationship between independent directors and
earnings management. This finding is in contrast to that found by Klein (2002), Xie
et al. (2003) and Peasnell et al. (2001) where independent directors are negatively related
to DAC. Nevertheless, the result is similar to that found by Chtourou et al. (2001), Park
and Shin (2003) and Choi et al. (2004) where there is no significant relationship between
outside directors and DAC.
The result also indicates that the competence of independent directors based on the
age of their tenure as board members, may not be adequate in assessing and evaluating
financial statements. Thus, the second hypothesis is rejected. The findings suggest
that independent directors in Malaysian firms have not been effective in carrying out
their monitoring functions. Arguably, their ineffectiveness in discharging their
monitoring duty may be due to the lack of expertise, lack of required skills and
knowledge in the business environment.
Apart from that, the insignificant relationship between DAC and the duality role
found in this study indicates that separating the role of the CEO and chairman has no
effective monitoring function in curbing earnings management, thus rejecting H3. The
CEO duality 10 90
Table III. Accounting qualification No qualification
Descriptive statistics for Audit committee competence 90 10
nominal independent and Big5 Non-Big5
control variables Auditors 81 19
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DAC 1
BDIND 0.016, 0.825 1
ACIND 2 0.032, 0.660 0.338, 0.000 * 1
BLOCK 0.033, 0.650 2 0.061, 0.398 0.021, 0.770 1
DUALITY 2 0.095, 0.187 2 0.015, 0.834 2 0.135, 0.061 * * 2 0.018, 0.799 1
BDSIZE 0.105, 0.145 2 0.254, 0.000 * 0.067, 0.355 2 0.069, 0.336 2 0.078, 0.282 1
ACQLFD 2 0.009, 0.905 2 0.033, 0.649 0.131, 0.069 * * 2 0.035, 0.632 0.05, 0.487 0.101, 0.160 1
INDTENURE 2 0.085, 0.238 0.030, 0.683 2 0.10, 0.885 0.190, 0.008 * 0.016, 0.829 0.080, 0.266 2 0.352, 0.000 * 1
ACMEETINGS 2 0.062, 0.394 0.144, 0.045 * 0.003, 0.965 2 0.217, 0.002 * 0.056, 0.439 2 0.128, 0.075 * * 2 0.081, 0.259 2 0.110, 0.127
ROA 0.177, 0.104 2 0.106, 0.143 2 0.111, 0.123 0.194, 0.007 * 2 0.053, 0.464 0.072, 0.322 0.047, 0.515 2 0.014, 0.846
LEV 0.059, 0.412 0.102, 0.159 2 0.055, 0.449 2 0.134, 0.063 * * 2 0.109, 0.129 2 0.038, 0.599 2 0.102, 0.158 0.095, 0.187
CFO 0.02, 0.779 2 0.099, 0.171 2 0.101, 0.162 0.270, 0.000 * 2 0.102, 0.157 0.101, 0.159 2 0.079, 0.276 0.083, 0.247
SIZE 2 0.117, 0.103 0.057, 0.430 2 0.002, 0.981 0.062, 0.91 0.027, 0.705 0.161, 0.025 * 2 0.011, 0.874 0.206, 0.004 *
GROWTH 2 0.167, 0.020 * 2 0.014, 0.845 0.093, 0.196 0.054, 0.453 2 0.090, 0.214 2 0.004, 0.961 0.054, 0.453 0.057, 0.426
BIG5 0.040, 0.576 0.087, 0.227 2 0.041, 0.574 0.217, 0.002 * 2 0.200, 0.005 * 2 0.097, 0.178 0.110, 0.126 2 0.073, 0.314
BUMI BD 2 0.018, 0.807 0.049, 0.498 0.124, 0.084 * * 0.107, 0.136 2 0.166, 0.021 * 0.049, 0.498 0.091, 0.214 2 0.183, 0.010 *
BUMI AC 2 0.019, 0.790 2 0.081, 0.263 0.024, 0.736 2 0.005, 0.946 2 0.081, 0.264 0.132, 0.066 * * 2 0.001, 0.985 2 0.049, 0.496
DAC
BDIND
ACIND
BLOCK
DUALITY
BDSIZE
ACQLFD
INDTENURE
ACMEETINGS 1
ROA 2 0.064, 0.373 1
LEV 0.095, 0.188 2 0.012, 0.869 1
CFO 2 0.106, 0.141 0.678, 0.000 * 2 0.065, 0.367 1
SIZE 0.241, 0.001 * 2 0.117, 0.104 0.250, 0.000 * 2 0.094, 0.190 1
GROWTH 0.002, 0.978 0.006, 0.939 2 0.136, 0.058 * * 0.105, 0.144 2 0.266, 0.000 * 1
BIG5 2 0.171, 0.017 * 0.134, 0.062 * * 2 0.199, 0.005 * 0.172, 0.017 2 0.062, 0.393 0.052, 0.475 1
BUMI BD 0.165, 0.021 * 2 0.111, 0.125 0.107, 0.139 2 0.033, 0.646 0.141, 0.051 * 0.133, 0.065 * * 2 0.059, 0.417 1 *
BUMI AC 0.095, 0.190 2 0.057, 0.433 0.204, 0.004 * 0.008, 0.915 0.119, 0.097 * * 0.111, 0.124 2 0.097, 0.178 0.740, 0.000 * 1
variables
Correlation analysis of
committee,
Board, audit
797
Table IV.
MAJ
Variables Predicted sign Coefficient p-value
21,7
Intercept 20.867 0.589
Independent non-executive directors 2 1.420 0.226
Average tenure of independent directors 2 20.024 0.242
CEO duality 2 20.366 0.311
798 Concentrated ownership 2 0.887 0.185
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Conclusion
The objective of the study is to examine the relationship between earnings management
and corporate governance characteristics, mainly board of directors and audit
committee attributes. The prediction made about good corporate governance practices
mitigating opportunistic earnings management activity was found to be inaccurate. All
corporate governance variables except for board size tested in this study have no
significant relationship with earnings management. The study uses the number of
directors on the board to represent board size. On average, Malaysian companies have
about eight board members. The regression analysis provides evidence that board size is
positively related to earnings management, thus implying that a smaller board size
could mean that the directors are more focused in solving any issues that may arise.
Conversely, a larger board may be difficult to control and potential conflicts of interest
may arise among directors, thus hampering the monitoring process of management
activity.
A plausible explanation for the insignificant relationship between corporate
governance mechanisms and earnings management may be based on the managerial
hegemony theory. This theory is in contradiction to the agency theory on the grounds
that board of directors are seen as ineffective in discharging their monitoring duties
due to management dominance over board matters. Also, the main reason for this
deficiency is the management’s control over the selection of outside board members
(Kosnik, 1987). Another apparent reason is attributed to the outside board members’
relative lack of knowledge in company’s affairs. This is not surprising as most
independent directors gain such knowledge as a by-product of their board service.
Given that they are busy with other activities, they are more reliant on management for
information. Although, in general, companies comply with the Code and the Bursa
MAJ Malaysia Listing Requirements, the corporate governance framework that is in place
21,7 may not serve its ultimate objectives if directors on the board do not posses the
required skills, knowledge and experience.
Boards that are not functioning would be detrimental to the organisation,
particularly to the shareholders. As clearly stipulated in section 169 (15) of the
Companies Act, 1965, directors are responsible for ensuring that the financial
800 statements prepared reflect a true and fair view of the state of the affairs of the
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Corresponding author
Rashidah Abdul Rahman can be contacted at: shidah@salam.uitm.edu.my
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