Company Financial Ratios, Company Ownership and Company
Conditions on Earnings Management
Indra Arifin Djashan and Ade Lawira
STIE Trisakti, Jl. Kyai Tapa No. 20, Grogol, Jakarta, Indonesia
Keywords: Earnings Management, Financial Ratio, Company Condition, Company Ownership, Operating Cash Flow,
Indonesia Stock Exchange.
Abstract: Recently, high-level scandals and financial crises that have occurred in several countries have brought issues
of corporate governance to the forefront of developing countries, emerging markets and transitional
economies. This scandal shook the integrity of accounting information and resulted in a decline in investor
confidence. This has made the company need to achieve significant progress to carry out corporate governance
to restore investor confidence in the quality of financial reporting. To achieve this, this paper proposes a
conceptual framework to investigate the relationship between financial ratios (profitability, leverage and
operating cash flow), ownership (Institutional ownership and managerial ownership), and company condition
(board size, firm size, sales growth) to earnings management among manufacturing companies listed on the
Indonesia Stock Exchange (IDX). Evidence from previous research shows that the company's financial ratios
(profitability) that have large profits and meet targets has very little chance of manipulating earnings.
1 INTRODUCTION
Perusahaan Terbatas (PT) is one of the most popular
business entities in the business world, and is widely
used by business actors in Indonesia as well as in
other countries. The company as an entity needs a
reference to evaluate the performance of the
management of the company over a period of time,
for which it is prepared and required a record called
the financial statements. PSAK No. 1 explains that
the financial statements are a record that presents the
financial condition of a company in a structured
manner in a given accounting period. The purpose of
the financial statements is to provide information
related to the financial condition and cash flows of a
company, beneficial to its users in terms of making an
economic decision (Financial Accounting Standards
Board, 2014).
Along with the advancement of technology and
information technology, business competition is
encouraged to happen more tightly. This is due to
price transparency and ease to obtain a product
quickly, for that the management to compete to obtain
the maximum profit possible. Earnings are often the
primary basis for assessing whether the company's
management has contributed to the best interests of
the company, leading to the birth of earnings
management practices by management.
Profit management is the way managers use to
systematically and systematically influence the rate
of profit by selecting accounting policies and certain
accounting procedures from existing accounting
standards and scientifically maximizing their utility
and / or market value (Scott, 2015). The Company
will determine whether the profits earned will be
allocated to shareholders or entirely retained for
reinvestment. The information asymmetry that
emerges between managers and shareholders
provides the flexibility for management to freely
determine the accounting methods and estimates used
in reporting corporate profits thus providing an
opportunity for earnings management (Indriani et al.,
2014).
To minimize the practice of earnings
management, Kusumawardhani (2012) explains that
the concept of Good Corporate Governance can be a
tool to monitor and control the actions taken by the
management company, so that the opportunistic
behavior of management to make earnings
management can be reduced. Implementation of the
concept of Good Corporate Governance can be seen
from the existence of parties such as managerial
ownership, institutional ownership, audit committee
44
Djashan, I. and Lawira, A.
Company Financial Ratios, Company Ownership and Company Conditions on Earnings Management.
DOI: 10.5220/0008487900440048
In Proceedings of the 7th International Conference on Entrepreneurship and Business Management (ICEBM Untar 2018), pages 44-48
ISBN: 978-989-758-363-6
Copyright
c
2019 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved
and independent commissioner in a company that
emphasizes on management responsibility to
mechanism and guidance and company objective, to
protect shareholder's interest.
Jensen and Meckling (1976) explain the agency
relationship is an agreement between the principal
and the agent for a delegation of the authority of the
work. Principal acts as the party giving the authority
of the company's operational management to the
agent in order to achieve the goals of the entity. In
practice within the company, the investor who invests
his capital for the company acts as a principal. While
the management company acts as an agent, which is
responsible to investors to manage the company's
operational activities in accordance with the trust that
has been given to him (Godfrey et al., 2010).
Separation of functions between ownership and
management can lead to conflicting agencies, because
in the case of decision-making, managers sometimes
do not act in the interests of shareholders. The
existence of such a difference of interest encourages
the owner to exercise control in order to ensure that
management actions are in conformity with the
company's objectives and to reduce profit
manipulation (Aygun et al., 2014).
Management has more information when
compared with the investor. This is what causes
information asymmetry. In addition, this also causes
management to take actions that are profitable for him
and very difficult for the investor to control the action
so that management can implement certain policies
that are not known by the investors (Lisa, 2012).
2 THEORETICAL FRAMEWORK
AND HYPOTHESIS
DEVELOPMENT
The Signal Theory explains that the activities of a
company can signal to the public. The Company
strives to provide a positive signal to external parties,
with the aim of improving the company's
performance and reducing the occurrence of
information asymmetry.
According to Ross (1977) that the management
seeks to provide the best possible information to the
public, this can lead to information asymmetry
between companies and external parties company. If
the company has increased leverage then the public
will give a positive signal and if it publishes shares
then the public will give a negative signal. The basis
of this theory explains that the company is likely to
compile financial statements that can generate the
best possible profit but not necessarily show the real
condition of real corporate finance.
Scott (2015) identified the existence of four
patterns performed by the management to make
earnings management, which are: (1) Taking a bath is
done when there is a bad situation that is unprofitable
and can not be avoided, that is by recognizing the
costs in the period to be (2) Income minimization is
done when the company obtains high profitability in
order not to get political attention, (3) Income
maximization is done by maximizing the profit in
order to obtain bigger bonus. From positive
accounting theory, managers can engage in
maximized reported net income for bonus purposes,
(4) Income smoothing is done by increasing or
decreasing profits to reduce reported profit
fluctuations so that the firm looks stable and not at
high risk.
In addition, Ahmed and Belkaoui (2000) in
Handayani and Rachadi (2009) explain earnings
information has 5 main objectives for parties
interested in the company. First, profit is used as the
basis for the company to determine the policy of
dividends and bonuses for shareholders. Second, the
profit becomes the basis for calculating the tax
obligations of companies that must be deposited to
the government. Third, profit is used as a basis for
economic and investment decision making. Fourth,
earnings information is useful for assessing the
prospects of the company for the future, and fifth,
profit is used as the basis for the assessment of the
performance of the management during a certain
period of time. The importance of this profit
encourages the manipulation of profit.
Good corporate governance mechanisms
emphasize two important things: the investor must get
the information that is appropriate to the real situation
and delivery on time. The second thing is to
emphasize that company management must disclose
information to investors regarding the company's
performance in a transparent and timely manner
(Guna and Herawaty, 2010).
This research uses Discretionary Accrual model to
measure earnings management by management.
Discretionary Accrual is the utilization of accrual
components in accounting conducted by the
management company, through its interference with
the preparation of financial statements. This
intervention causes reported earnings do not reflect
actual company conditions (Guna and Herawaty,
2010).
Researchers classify eight variables into three
major groups, namely the Financial Ratio, Ownership
company, and Company conditions. Financial Ratio
Company Financial Ratios, Company Ownership and Company Conditions on Earnings Management
45
consists of: profitability, leverage, and operational
cash flow. Ownership company comprised of
institutional ownership and managerial ownership
Company conditions consists of board size, company
size, and company growth. Based on the theoretical
description above, the research model formulated in
this research is as follows:
Figure 1: Research Model.
H1: Board size affects earnings management.
H2: Managerial ownership affects earnings
management.
H3: Institutional ownership affects earnings
management.
H4: Firm size affects earnings management.
H5: Profitability affects earnings management.
H6: Leverage affects earnings management.
H7: Operating cash flow affects earnings
management.
H8: Sales growth affects earnings management.
3 RESEARCH METHOD
The sample used in this research is a manufacturing
company consistently listed in Indonesia Stock
Exchange (BEI) in 2014 until 2016. The sample
selection is done by purposive sampling method that
is the selection of sample based on certain criteria
according to the purpose and research problem
(Sugiyono, 2012). The results of sample selection can
be seen in table 1 below:
Table 1: Sample Selection Procedure.
Earnings management is measured using the
discretionary accruals method, which is a modified
cross-sectional model of Jones, in absolutes as
research has been done by (Bassiouny et al., 2016).
The stages for obtaining a discretionary accrual value
are expressed in the following equation:
TA
t
= NI
t
-
N
CF
t
(1)
TA
it
/A
it-1
= β
1
(1/A
it-1
) + β
2
((∆REV
it
−∆REC
it
)/
A
it-1
) + β
3
(PPE
it
/A
it-1
) + εit
(2)
NDA
it
/A
it-1
= β
1
(1/A
it-1
) + β
2
((∆REV
i
t
−∆REC
i
t
)/A
i
t
-1
) + β
3
(PPE
i
t
/A
i
t
-1
)
(3)
DAC
it
= TA
it
/ A
it-1
- NDA
it
/ A
it-1
(4)
TAt Total Accruals in period t, NIt Net income t
period, NCFt Cash flow from operating activity
period t, NDAit Nondiscretionary accruals period t,
Ait-1 Total corporate assets i period t-1 ΔREVit
Changes in corporate income i from period t-1 to
period t, ΔRECit Changes of corporate receivables i
from period t-1 to period t, PPEit Gross property,
plant and equipment company i period t, εit residual.
Board Size is the number of members of the board
of directors and board of commissioners who are in a
company (Alzoubi 2016). Here are the
measurements:
BOD = Number of members of the board of
directors and board of commissioners of the
compan
y
(5)
Managerial ownership is the number of shares of the
company owned by the management of the company
personally and subsidiaries, as well as its affiliates
(Agustia, 2013).
(6)
Institutional ownership is the number of shares owned
by the institutional company (external), such as
investment companies, banks, insurance companies
and other institutions (Mahariana and Ramantha,
2014).
(7)
The size of a company is a small size of a company
that can be seen from several categories such as total
assets, total sales, average sales, market value of stock
companies, etc. but generally used is total assets
(Yuliana and Trisnawati, 2015).
F
_
SIZE = Ln (Total Aset) (8)
Profitability is the company's ability to earn an overall
profit. Profitability is measured by the proxy of ROA
measurement that is the ratio between net profit after
tax which is obtained with total assets of company
(Alzoubi 2016).
ICEBM Untar 2018 - International Conference on Entrepreneurship and Business Management (ICEBM) Untar
46
(9)
Leverage is the percentage of company assets
financed by using debt (Susanto, 2013).
(10)
Operating cash flows represent cash receipts and
disbursements from operating activities of the
company. Operating cash flow is an indicator of the
company's performance in generating cash flow for
operational activities (Yuliana and Trisnawati 2015).
(11)
Sales growth represents a change in total sales in year
t with total sales in the previous year compared to
total sales in the previous year (Savitri 2014).
1
1
(12)
4 RESEARCH RESULTS
The results of descriptive statistics and hypothesis
testing results can be seen in table 2 and table 3
below:
Tabel 2: Descriptive Statistics.
Company Financial Ratio in Profitability (ROA)
has a Sig value. of 0.007 less than 0.05 which means
ROA is accepted. Profitability (ROA) has a
regression coefficient of -0.145 which indicates a
negative direction and a significant value (sig.) of
0.007. This means that profitability negatively affects
earnings management, this explains that firms that
have large profits and meet targets have very little
chance of profit manipulation. The results of this
study are consistent with research conducted by
Alzoubi (2016) and Abbadi et al., (2016). From the
results of the study, it was seen that company
ownership (institutional ownership and managerial
ownership) variables and company conditions (board
size, firm size and sales growth) did not have a
significant impact. As a result, it can be said that
companies having high asset returns are less likely to
manipulate their income. According to (Kothari et al.,
2005; Machuga and Teitel, 2007) managers intend to
increase profits obtained in other words manipulating
income upwards makes the company more attractive.
Tabel 3: t- Test result.
5 CONCLUSIONS
Based on the results of the research can be concluded
that profitability (ROA) affects earnings
management. While the board size, managerial
ownership, institutional ownership, firm size,
leverage, operational cash flow, and sales growth
have no effect on earnings management. A high rate
of return on assets will affect earnings management.
When the performance of the company is declining,
then management increases profit on the other hand
when the company is improving its performance then
management is not motivated to do earnings
management. This research has some limitations that
is the object of research only use manufacturing
companies so can not be generalized to the type of
industry others and the research period is relatively
short ie 2014-2016.
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