Academic journal article International Journal of Business and Management Science

External Agency Monitoring Mechanisms and Earnings Management for Improved Financial Reporting

Academic journal article International Journal of Business and Management Science

External Agency Monitoring Mechanisms and Earnings Management for Improved Financial Reporting

Article excerpt


The collapsed of some large companies such as WorldCom, AIG and some others resulting partially from accounting manipulation or earnings management has raised serious questions about the effectiveness of different monitoring devices (Benston and Hartgravcs, 2002; Lin ct al., 2006; Putman ct al., 2009).

Similarly in Malaysia, several recent corporate scandals that have been reported were Sime Darby, Transmile and Perwaja Steel. Malaysia has introduced the Malaysian Code of Corporate Governance (2000) and Bursa Malaysia Revamped Listing Requirement (2001) due to lack of transparency, disclosure and accountability in 1997 economic crisis (Rashidah and Fairuzana Haneem, 2006; Johnson et al., 2000). This measure was taken to boost investors' confidence and improve the credibility and accountability of financial information produced by listed companies. Whenever managers have incentive to pursue their own interest at shareholders expense, it means agency problems have arisen and several mechanisms could be implemented to reduce the problems (Agrawal and Knocbcr, 1996).

According to Mohammed (2009), the Saudi Stock Market faced an extraordinary crash at the beginning of 2006, which leads the Capital Market Authority (CMA) to suspend the trading of two firms. This event created a serious question about the effectiveness of different monitoring devices that were presumed to protect investors' interests in Saudi Arabia. In Malaysia, the 1997 economic crisis has exposed serious weaknesses in corporate governance practices namely, weak financial structure, over-leveraging by companies, lack of transparency, disclosure and accountability (Rashidah and Fairuzana Haneem, 2006). This issue also relates to the auditor changes where there is an opinion suggesting that auditor typically resign or fired before they get to the point of issuing negative opinion (Defond and Subramanyam, 1998). This means that companies which have problematic issues will try to find auditors who are willing to issue a clean opinion although it is not. Meanwhile, a study by DeAngelo (1981) showed that the quality auditor (i.e., a big auditor) tends to reduce discretionary accruals and therefore improve the governance and transparency of a firm.

However, the limited studies have examined the implementation of agency monitoring mechanisms from multiple stakeholders to protect investors' interests and control managerial opportunistic behavior. Docs good agency monitoring mechanism or corporate governance codes could mitigate the problems? In making such an assumption, there are some characteristics that have significant impact to this situation. The audit quality, dividend and leverage of a company are some that will be studied in this paper. In order to integrate all these main issues, it is necessary to examine the factors simultaneously. It aims to provide a review on how the firms monitor the earnings management practices through agency monitoring mechanism.


Earnings Management

It is important to have a good understanding of 'earnings' as there are various terms used for it. It is also known as the 'bottom line' or 'net income'. Investors and analysts look into earnings to determine whether a particular stock is attractive or not while management wishes to show earnings at a certain level to achieve their desired aim or to meet the expectation of some stakeholders (Ahmed, 2001). That is, if a company shows an increment in earnings although it is only a short term measurement, it means very good news to the stakeholders. So, there is a strong incentive for management to manipulate the earnings to please the stakeholders and the term "earnings management" arises.

There are many reasons why managers tend to manage the earnings. Healey and Wahlen (1999) found that firms manage the earnings to window-dress financial statements prior to public securities offerings, to increase corporate managers' compensation and job security, to avoid violating lending contracts, or to reduce regulatory costs or to increase regulatory benefits. …

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