Earnings Management, Corporate Governance and Corporate Performance Among Malaysian Listed Companies

Journal of Environmental Treatment Techniques

2020, Volume 8, Issue 3, Pages: 1124-1131

J. Environ. Treat. Tech.

ISSN: 2309-1185

Journal web link: http://www.jett.dormaj.com

Earnings Management, Corporate Governance and

Corporate Performance Among Malaysian Listed

Companies

Mojtaba Nasiri*, Suresh Ramakrishnan

Azman Hashim International Business School (AHIBS), Universiti Teknologi Malaysia, Malaysia

Received: 06/02/2020

Accepted: 12/07/2020

Published: 20/09/2020

Abstract

There are several explanations for lack of transparency regarding financial reporting however the most significant is earnings management

activities that managers follow. Admittedly, managers manipulate accounting information by using EM (Earnings Management) practices to

achieve certain results. Corporate governance, which its primary objective is to spot possible structures in which a corporation's shareholders

have greater power and control over managers to protect and further their rights, and it has recently brought an interesting topic to researchers

and policymakers around the world. Most research has emphasized the relationship between corporate governance and company performance,

but still, only a few investigations have looked at the moderator characteristic of corporate governance on corporate performance from

different perspectives. This study aims at investigating whether corporate governance, utilizing data from listed companies in Bursa Malaysia,

impacts the relationship between earnings management and the firm ’s performance. This study utilizes panel data analysis and uses FTSE

Russell data by applying the intersection method to the constituents of the FTSE Top 100 Bursa Malaysia from 2011 to 2015. The findings

show that DAs have a considerable impact on the ROA, ROE, Tobin's Q and EVA of companies in a poor governance system. This research

reveals that managers in weakly managed companies are far more likely to misuse accounting powers than in well managed companies,

leading to a decline in corporate performance. Managers are likely utilizing DAs to modify the financial profits; however, this produces a

rather more significant reversing impact in corporate interest in the period ahead. Likewise, DAs inside an efficient governance structure are

strongly and substantially related to firm performance.

Keywords: Corporate governance; Firm performance; Earnings management

Introduction¹

potentially influence performance, should be examined.

Moreover, earnings management (EM) is essential for

shareholders and regulators globally. This is because EM is

correlated to executives conducting themselves purposefully, in

particular misrepresenting financial reports. (3). To order to

control earnings, management uses accounting strategies to adjust

the accounting figures and to control accrual identification, i.e.

In recent years there has been an increase in the number of

studies that have examined the performance of firms, which has

subsequently led to an expansion in the body of literature. Due to

the significant importance of performance measurements

implemented in various corporate firms, evaluation of firm

performance has become increasingly essential. Furthermore, the

challenges that various firms encountered during the Asian and

global financial crises, has consequently impacted the

performance of these corporate firms (1). When a business is

incapable of achieving its obligation commitment, it results in

poor performance. Since the stock market plays a significant role

in a countries’ economic growth, its performance measurement

has become a central topic in management research on financial

performance (2). The increasing number of companies in the

competitive environment has emphasized the need for addressing

their performance. A companies’ performance listed in the stock

market can be evaluated by assessing the past and current trends

and subsequently determining future estimates. In order to

achieve short and long-term obligations, various factors that may

'accounting choice management.' In addition, managers can shape

various operational choices that could impact actual cash flow

transactions, i.e. 'economic benefit management'(3-10).

Managers are usually compelled to manage earnings because of

various market pressures as well as the need for self-preservation

to prevent breaking contractual agreements (11-13). Moreover,

during a financial crisis, there would be a higher tendency among

managers to manage earnings (14), as listed below. The

following. A few of the largest corporations were behind the

global economic crisis that emerged in the united states (15, 16).

Crotty (2009) called it the "severe economic collapse since the

Great Depression"(17, 18). The extreme recession "pushed the

world economy to the verge of depression" as said by Crotty

Corresponding author: Mojtaba Nasiri, Azman Hashim International Business School (AHIBS), Universiti Teknologi Malaysia, Malaysia.

E-mail: nmojtaba3@live.utm.my and mojtaba.1986.nasiri@gmail.com.

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2020, Volume 8, Issue 3, Pages: 1124-1131

(2009) (17). Rudd (2009) has also referred to the financial

selection.

collapse as "one of the biggest attacks on world economic

stability," triggering a "significant slump in world trade and

global financial crisis"(3, 16, 19). The US financial crisis

immediately reached the globe, negatively impacting the world's

economy and world capital markets (20-23). Ultimately, the

Asian economies also were disrupted by the global financial

meltdown, including the Malaysian economy (24-26).

About 2008 the adverse impact of the United States financial

crisis in the Malaysian economy had detrimental impacts on

financial and trade networks (19, 27). In the fourth quarter of

This study aims to investigate whether the relationship

between earnings management and firm performance is affected

by corporate governance, in the Malaysian context. Since a

corporate governance mechanism involves

set of

comprehensive structures that could comprise of opposing

attributes, the various factors of governance should be

incorporated with specific objective criteria, when evaluating the

quality of governance of an organization (37).

A brief summary of the development of the Malaysian

Corporate Governance Code will be presented. This study

attempts to elucidate the role of corporate governance in

influencing the association between earnings management and

company performance and identifying which particular

components might have a greater impact on this relationship. This

study explores two fundamental issues related to corporate

governance and corporate performance that have yet to be

addressed sufficiently in the existing literature, specifically how

different components of corporate governance may potentially

affect the relationship between earnings management and firm

performance. This study also considers the relevant existing

literature and will elaborate on the processes of corporate

governance and concentrates particularly on the concept of

agencies. The importance of this study will be further

demonstrated through an academic and technical context. The

current study will investigate corporate governance in the

Malaysian context, as it is a good model as an emerging market

that is developing. Thus, transparency of information is necessary

in order to achieve more stable and smooth trends, as well as to

limit fraud potential.

008, Malaysian Gross Domestic Product (GDP) declined by 12

percent and declined significantly in the subsequent year. In early

009, exports dropped dramatically by 28% compared to the prior

year (28). Furthermore, foreign direct investments plummeted 17

percent in 2008 compared to the previous year, however direct

investments overseas by Malaysian companies increased (28).

This was indicative of funds flowing out of Malaysia during this

particular financial crisis, which contributed further in adversely

affecting Malaysia’s real economy, causing a loss in industrial

production and jobs (28). According to The World Bank Report

(2009), as much as 120,000 workers were reported to have been

retrenched in Malaysia (29). In addition, during the financial

crisis, the Malaysian stock market was more volatile and had

increased leverage. Consequently, managers of Malaysian

companies were more pressured to manage earnings during this

crisis period and following it, to retain investors amidst the highly

volatile stock market, and also to avoid violating debt covenants

during increased leverage. These various reasons may have

pushed them to make the decisions they did, to try and safeguard

the survival of their company, and subsequently avoiding

retrenchment of their employees (30, 31).

Conversely, as reported by the International statistics, the

Asian financial crisis was believed to affect Asian economies

more than the global financial crisis (22, 32). Thus, it was

believed that Asia was not affected as severely by the global

financial crisis in comparison to other continents. From the

literature (33) it has been demonstrated that, during a crisis phase,

companies are inclined to use income decreasing EM. The

discretionary accrual method of deliberately reducing earnings

management through the "theory of big bath " (3). Thus,

Malaysian companies could also have resorted to applying the

reverse during the global financial crisis phase, by managing

earnings downwards (decreasing revenue) instead of upwards

Background of study

During the global financial crisis, EM was studied in Europe

by two key reports, Iatridis and Dimitras (2013) and Filip and

Raffournier (2014). The research study of Iatridis and Dimitras

(2013) included firms comprising five European countries,

namely Greece, Ireland, Italy, Portugal and Spain; while the

sample of Filip and Raffournier (2014) included 16 European

countries. In order to evaluate EM, the former used discretionary

accruals, and their findings showed that Portugal, Italy and

Greece were involved in more EMs, and Ireland was involved in

no EMs. In Spain, however, the results for EM were in dispute

(38, 39). In order to evaluate EM and smoothing income controls,

Filip and Raffournier (2014) have used discretionary accruals.

Throughout the period 2006 to 2009, during which European

businesses implemented IFRS, the analysis was carried out.

Based on the result obtained, the EM decreased dramatically in

the financial crisis era, which contributed both to positively and

negatively excesses. (39). The Cimini (2015) report also explored

European EM activities but for a longer period, from 2006 to

(

increasing revenue). So, it is extremely likely that Malaysian

companies conducted EM during the global financial meltdown

34). They may have studied more EM or introduced more

(

revenue-enhancing EM procedures, or more revenue-decreasing

EM practices. There is, however, a lack of EM research by

Malaysian firms during the global financial crisis, and the

investigation is therefore required in order to analyse EM in

Malaysia during the recent global financial crisis (35).

In order to evaluate and predict the severity of EM practices

by Malaysian companies during a crisis period, EM must initially

be assessed during a non-crisis period (36). ASEAN countries

were faced with the financial crisis in 1998 and the current

research is likely to be more representative and effective, as this

study aims to investigate specific nations from the Asian market

that were clearly affected by the Asian financial crisis. Taking

into consideration these criteria, a developing and rapidly

growing economy like Malaysia would be the most suitable

012. It was found similar results, with a decrease in abnormal

accruals across most of the euro nations investigated during the

crisis (40).

The Generally Accepted Accounting Principles (GAAPs)

facilitate managers to practice flexibility throughout the

accounting process while preparing financial reports. Managers

apply various accounting options to improve interrelated

decision-making like expense control, capital budgeting and

transfer pricing (41). However, this also allows managers to

potentially abuse their authority while taking advantage of the

interests of other groups involved. There has been a lengthy-

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2020, Volume 8, Issue 3, Pages: 1124-1131

standing controversy in accounting research, concerning

managers who may potentially exploit specific financial

instruments in a manipulative way. (11, 42).

Earlier studies have demonstrated how managers prefer

specific accounting techniques and how certain methods

influence the quality of corresponding corporations. Holthausen

countries, EM in Malaysia is worse than Thailand, Taiwan, India,

and Pakistan. Due to the importance of EM and its wealth of

research, little is known about earnings management in family

ownership (67). Furthermore, top 15 families in Malaysia were

also found to control assets worth 76% of the country’s gross

domestic product (GDP) as reported by the Malaymail online on

April 17, 2015, edition (68).

(1990) presented three viewpoints on the use of accounting

methods namely, duplicitous behaviour, effective contracting and

data (43, 44). Several previous research seemed to concentrate on

the opportunistic point of view, indicating that business

executives are likely to misuse accounting efficiency in order to

increase their own money at the cost of shareholders (45-48).

Conversely, the active contracting view suggests that accounting

practices are effective when managers look after the interests of

investors and successfully apply accounting decisions to mutually

maximize decision-making, as well as react appropriately to

various circumstances (49, 50). Specifically, accounting methods

can be selected to demonstrate the assumptions of management

regarding future cash flows of an organization, which would lead

to increased information about earnings that is compatible with

the information context (51, 52). Accounting strategies could

thus attain substantial benefits and stockholders (53-55).

Previous studies have demonstrated the diverse consequences

of earnings management on corporate performance. The

manipulation of profits may be practiced under opportunistic

circumstances by managers by exploiting the flexibility of

accounting however, the framework of corporate governance

plays an integral part in curbing deceptive earnings management

and consequently making sure that managers work in the favour

of investors (51, 52). In recent years, extensive research has been

carried out to investigate whether corporate governance prevents

or controls the “avaricious actions” of managers in terms of

accounting preferences (56-58) and increases firm benefit (59-

According to Berle and Means (1930), the distribution of

equity among financial investors tends to decrease control and

moves authority to the managerial groups. Administrative staff

and shareholders have specific profits, and potential conflicts

could arise that could be problematic to the organization (69).

Jensen and Meckling (1976) explained how under such

circumstances where the investor is the principal and the

supervisor the agent, could be potentially problematic and have a

negative impact on firm performance and its value (70).

Likewise, Jensen and Meckling described how conflicts could

arise from the debt link between creditors and organizations.

Furthermore, La Porta, Lopez-de-Silanes, Shleifer, and Vishny

(1997) reported that(71), both major and minor investors are

being subjected to additional serious agency problems,

particularly in nations which have inadequate investor security. It

is apparent that various factors and conditions affect

agency relationships within an organization. Thus, overcoming

these conflicts, specific principles and guidelines should be

implemented in order to guarantee that organizations are well

governed and efficiently organized to improve and sustain

progress. Without such guidelines and procedures in place, these

potential problems could adversely affect firm performance (63,

72). The agency theory has suggested two kinds of governance

elements for reducing agency problems namely; external and

internal structures. The external structure includes, the market for

corporate control, the variable and product market and the legal

structure (70).

2). Organizations that employ powerful governance systems are

generally less likely than organizations with weak governance

mechanisms, to practice EM (56, 57). Tang (2012 ) indicated that

entities with larger boards, higher institutional ownership and a

non-dual management structure are more vulnerable to scrutiny

and consequently much less likely to gain from risky accounting

options than issuers without these components (62). Chen et al.

The internal systems, on the other hand, include the

arrangement of ownership, the board of directors, remuneration

of the company, and financial policies. Agency theory control

instruments could potentially provide the required assurances as

well as provide balanced governance into the processes of an

organization. Additionally, more order is placed on both investors

and administration due to these factors. A number of studies

carried out in various countries have investigated the correlation

between corporate performance, earnings management

and corporate governance mechanisms. These studies revealed

that undeniably corporate governance practices could protect

shareholders, the organization's value as well as improve

corporate governance (73-77).

(2007b) indicated that effective corporate governance could

theoretically mitigate the manipulation of versatility in

accounting and thus increase financial performance (56).

Corporate ownership is focused in East Asia, whereas in the

U.S. and UK it differs from prevalent ownership. Practices in

developing economies usually make use of “pyramid

frameworks” and “crossholdings” between organizations in order

to improve their control rights, which leads to an extensive gap

between their control rights and cash flow rights (63). Thus in

East Asian organizations, there is usually more discord between

regulating investors and minority shareholders rather than

between management and investors (64, 65). Subsequently, a

conflict between groups prompts owners to capture minority

interests through earnings management. Leuz and Wüstemann

Research objectives

To examine the effect of corporate governance mechanisms

on the relationship between earnings management activities and

firm performance in listed companies of Bursa Malaysia.

Data analysis and Scope of the study

Preliminary analysis of the data collected was completed to

(2003) conducted a survey regarding 31 countries to benchmark

EM, and the Malaysian stock market was ranked number 20 in

overall earnings management (66). Enomoto et al. (2015)

compared two types of EM (accrual earnings management, AEM

reflect the period of the years 2011 until 2015. At this stage,

corporations with any missing data were excluded from the

research, whereby the final sample size was reduced to 84 listed

companies in Bursa Malaysia from FTSE Top 100 index. To

evaluate the interactions proposed from the hypotheses as stated

real earnings management, REM) across 38 countries and

found that two types of EM in Malaysia are more pervasive than

other nations, particularly REM. Out of the four South East Asian

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2020, Volume 8, Issue 3, Pages: 1124-1131

in the conceptual platform, the STATA 12.1 statistical program

and SPSS 22 were utilised. In this study, panel data analysis was

applied, and different steps were available for a diagnostic test.

EVA it = α0 + B1DACit + B2CEODit + B3 DS it + B4SBS it +

B5BM it + B6SBM it + B7 ID it + B8 NID it + B9 FO it + B10

SX it + B11 WB it + B12 AMG it +B13 NRCM it +B14 ACI it

B15 (DACit * CEODit ) + B16 (DACit * DS it ) + B17 (DACit

SBS it ) + B18 (DACit * BM it ) + B19 (DACit * SBM it ) +

Hypotheses and Models

Based on the literature regarding the objective, this study

B20 (DACit * ID it ) + B21 (DACit * NID it ) + B22 (DACit *

FO it ) + B23 (DACit * SX it ) + B24 (DACit * WB it ) + B25

recommends Hypotheses 1 to 4 and model 1 to 4 as follows:

Hypothesis 1: Corporate governance activities have a significant

effect on the relationship between earnings management and the

ROA of the listed companies in Bursa Malaysia.

(DACit * AMG it ) + B26 (DACit * NRCM it ) + B27 (DACit *

ACI it ) + B28 LEV it +B29 LMV it + B30 MB it +e it

Corporate Governance as moderator (CEOD = CEO Duality,

DS = Board size, SBS = Supervisory Board Size, BM = Board

Model 1

Meetings, SBM

Supervisory Board Meetings, ID

ROA it = α

it + B SBM it + B

it + B12 AMG it +B13 NRCM it +B14 ACI it +B15 (DACit * CEODit

+ B16 (DACit * DS it ) + B17 (DACit * SBS it ) + B18 (DACit * BM

it ) + B19 (DACit * SBM it ) + B20 (DACit * ID it ) + B21 (DACit

NID it )&nbs