The copyright © of this thesis belongs to its rightful author and/or other copyright owner. Copies can be accessed and downloaded for non-commercial or learning purposes without any charge and permission. The thesis cannot be reproduced or quoted as a whole without the permission from its rightful owner. No alteration or changes in format is allowed without permission from its rightful owner.
OWNERSHIP STRUCTURE, SUKUK ISSUANCE AND REAL EARNINGS MANAGEMENT: THE MODERATING EFFECT
OF SHARIAH COMPLIANCE AND POLITICAL CONNECTIONS
ALIANA SHAZMA AMIR BINTI AMIR
DOCTOR OF PHILOSOPHY UNIVERSITI UTARA MALAYSIA
SEPTEMBER 2019
OWNERSHIP STRUCTURE, SUKUK ISSUANCE AND REAL EARNINGS MANAGEMENT: THE MODERATING EFFECT OF SHARIAH COMPLIANCE
AND POLITICAL CONNECTIONS
By
ALIANA SHAZMA AMIR BINTI AMIR
Thesis Submitted to
Tunku Puteri Intan Safinaz School of Accountancy, Universiti Utara Malaysia,
in Fulfilment of the Requirement for the Degree of Doctor of Philosophy
PERMISSION TO USE
In presenting this thesis in fulfilment of the requirements for a postgraduate degree from Universiti Utara Malaysia, I agree that the Universiti Library may make it freely available for inspection. I further agree that permission for the copying of this thesis in any manner, in whole or in part, for scholarly purpose may be granted by my supervisor(s) or, in their absence, by the Dean of Tunku Puteri Intan Safinaz School of Accountancy where I did my thesis. It is understood that any copying, publication, or use of this thesis or parts thereof for financial gain shall not be allowed without my written permission. It is also understood that due recognition shall be given to me and to Universiti Utara Malaysia (UUM) for any scholarly use which may be made of any material from my thesis.
Requests for permission to copy or to make other use of materials in this thesis, in whole or in part should be addressed to:
Dean of Tunku Puteri Intan Safinaz School of Accountancy Universiti Utara Malaysia
06010 UUM Sintok Kedah Darul Aman
ABSTRACT
This study examines the relationship between ownership structures, Sukuk issuance and real earnings management by Malaysian public listed companies. It also investigates the moderating roles of Shariah compliance and political connections on the relationship between ownership structures and real earnings management. The study uses 850 firm-year observations drawn from the population of non-financial companies for the period of 2012-2016. Real earnings management is measured using Zang (2012) model. Ownership structures are divided into three types: managerial ownership, external block-holder ownership and family ownership. To achieve the objectives of this study, quantitative method of analysis is employed. The data analysis method used is panel data technique using Feasible Generalized Least Squares (FGLS) to test for the long run relationship. With reference to the agency theory, Maqasid As-Shariah theory, Islamic ethical perspectives and reputational theory, the present study finds that ownership structures are effective mechanisms in mitigating real earnings management while Sukuk issuance are able to provide benchmarks that the managers’
opportunistic behaviour to engage in real earnings management is less prevalence. Besides, the moderating role of Shariah compliance strengthens the effectiveness of ownership structures as monitoring mechanism in mitigating real earnings management. However, the moderating role of political connections weakens the effectiveness of ownership structures in reducing real earnings management. By examining all the determinants of real earnings management, it may assist standard setters, regulators and authorities to stay alert to manifest approaches to attenuate such practices. It is of great significance to assess Malaysian companies since it provides insights into Malaysian corporate environment through examination of companies’
real earnings management practices.
Keywords: real earnings management, ownership structures, Sukuk issuance, Shariah compliance, political connections
ABSTRAK
Kajian ini mengkaji hubungan antara struktur pemilikan, terbitan Sukuk dan pengurusan pendapatan sebenar oleh syarikat tersenarai awam di Malaysia. Ia juga menyiasat peranan perantaraan pematuhan Syariah dan hubungan politik ke atas hubungan di antara struktur pemilikan dan pengurusan pendapatan sebenar. Kajian ini menggunakan 850 pemerhatian firma-tahun yang diambil daripada populasi syarikat bukan kewangan untuk tempoh 2012- 2016. Pengurusan pendapatan sebenar diukur dengan menggunakan model Zang (2012).
Struktur pemilikan dibahagikan kepada tiga jenis: pemilikan pengurusan, pemilikan pemegang blok luar dan pemilikan keluarga. Untuk mencapai matlamat kajian ini, kaedah analisis kuantitatif digunakan. Kaedah analisis data yang digunakan adalah teknik data panel dengan menggunakan Feasible Generalized Least Squares (FGLS) untuk menguji hubungan jangka panjang. Dengan merujuk kepada teori agensi, teori Maqasid As-Syariah, perspektif etika Islam dan teori reputasi, kajian ini mendapati bahawa struktur pemilikan adalah mekanisma yang berkesan dalam mengurangkan pengurusan pendapatan sebenar manakala terbitan Sukuk dapat memberikan tanda aras bahawa tingkah laku oportunistik para pengurus untuk terlibat dalam pengurusan pendapatan sebenar adalah kurang berkelaziman. Selain itu, peranan perantaraan pematuhan Syariah menguatkan keberkesanan struktur pemilikan sebagai mekanisma pemantauan dalam mengurangkan pengurusan pendapatan sebenar. Walau bagaimanapun, peranan perantaraan hubungan politik melemahkan keberkesanan struktur pemilikan dalam mengurangkan pengurusan pendapatan sebenar. Dengan mengkaji semua penentu pengurusan pendapatan sebenar, ia boleh membantu penggubal piawaian, pengawal selia dan pihak berkuasa untuk sentiasa peka dalam menyatakan cara untuk melemahkan amalan sedemikian.
Ia amat penting untuk menilai syarikat-syarikat Malaysia memandangkan ia memberikan pandangan tentang persekitaran korporat Malaysia melalui pemeriksaan amalan pengurusan pendapatan sebenar syarikat.
Kata kunci: pengurusan pendapatan sebenar, struktur pemilikan, terbitan Sukuk, pematuhan Syariah, hubungan politik
Acknowledgement
In the name of Allah, the Most Beneficent and the Most Merciful.
My utmost gratitude to Allah S.W.T in giving me good health, perseverance, strength, opportunities and ideas to complete this PhD journey. Indeed, completion of a doctorate program is an enduring and daring adventure with ups and downs during the process. Yet, it is worth. Without His Mercy, I would not be able to complete this arduous journey. Anyhow, Allah mentioned twice in Al-Quran (94:5) Surah Al-Inshirah: “With Every Difficulty, There is Relief.” As such, no matter how trying the times may be, hardship can never overwhelm Allah’s Blessings. Alhamdulillah!
This PhD study would not have been possible without the corporation and support extended by my parents. I gratefully acknowledge the funding received towards my PhD from my father, Prof Madya Amir Bin Zainol Abidin. Frankly, I found that the journey sometimes is too laborious. There are critical times for me and what I need the most is only prayers, love and motivations. For that, my parents would never let me down. They are persistently counting days for me to finish my study. I am so blessed to have them with me because I am sure that
“the prayers of our parents are the invisible hand that saves our day”. To my mother, Madam Zabedah Binti Hanafi, thank you for being supportive, sweet, loving, caring, gentle and understanding. To my father, Prof Madya Amir Bin Zainol Abidin, thank you for showing me what a hardworking man looks like, always putting our family first and keep believing in me, even when I didn’t believe in myself. In shaa Allah I am so enthusiastic to continue his legacy to spread the knowledge to others. I love you both Mama and Papa. To all my family members, you are part and parcel of my PhD life, your unwavering prayers and supports made me strong.
My deep appreciation goes out to my supervisors, Dr Hasnah Binti Shaari and Dr Arifatul Husna Binti Mohd Ariff for their patience guidance, encouragement and advice they have provided throughout my time as their student. I have been extremely lucky to have them who cared so much about my work, and who responded to my questions and queries so promptly.
No words to describe but they are amazing. I benefit a lot from their supervision.
To my dearest best friend, Madam Aine Yazlina Binti Abdul Yaziz, she is such a great blessing and every day I thank Allah for her mere existence. For these 23 years of friendship and hopefully to be forever, thank you for dealing with my immaturities and sometimes hard to
deal with but she never abandoned me. Instead she still tries to understand, motivate and love me behind my flaws. She simply makes everything brighter. I would also like to say a heartfelt thank you to another best friend, Madam Siti Shahirah Binti Ahmad. I am lucky to have her by my side during this journey. Thank you.
Importantly, a very special thank you to Dr Salau Abdulmalik for his invaluable advice, motivation and always being so supportive. I am also very grateful to Dr Mourad Boudiab and his family, Dr Sunusi Garba, Dr Husaini Bala, Dr Mohammed Saleh Nazzal, Dr Armaya’u Sani, Dr Shafawaty Shabri, Dr Noor Marjan, Mr Abdallah A.S. Fayad, Dr Zaharaddeen Salisu Maigoshi, Dr Marwan Tarawneh and Dr Musibau Hammed Oluwaseyi who helped me in numerous ways during various stages of my PhD. I appreciate you all.
Moreover, I would like to acknowledge the academic and learning support provided by the University library; it was of great assistance towards the success of this thesis. Finally, it is an honour to express my deepest appreciation to those who involved, either directly or indirectly. They are friends who persistently provided practical assistance and friends who are willing to lend their ears and give words for encouragement. To other friends, even though their names are not mentioned, but they know who they are! I believe it is the power of prayers from everyone who has pledged to make my dream comes true! Thus, I am so indebted with them! Thanks for everything and only to Allah I ask to repay your kindness. Aamiin Ya Rabb.
TABLE OF CONTENTS
TITLE PAGE I
CERTIFICATION OF THESIS WORK II
PERMISSION TO USE III
ABSTRACT IV
ABSTRAK V
ACKNOWLEDGEMENT VI
TABLE OF CONTENTS VII
LIST OF TABLES VIII
LIST OF FIGURES IX
LIST OF APPENDICES X
LIST OF ABBREVIATIONS XI
CHAPTER 1: INTRODUCTION
1.0 Background of the Study 1
1.1 Problem Statement 7
1.2 Research Questions 18
1.3 Objectives of the Study 18
1.4 Significance of the Study 19
1.4.1 Theoretical Significance 21
1.4.2 Practical Significance 23
1.5 Scope of the study 24
1.6 Organization of Thesis 29
1.7 Summary 30
CHAPTER 2: LITERATURE REVIEW
2.0 Introduction 31
2.1 Earnings Management 32
2.1.1 Concept of Earnings Management 33
2.1.2 Types of Earnings Management and Measurement 33
2.1.2.1 Accrual Earnings Management 33
2.1.2.2 Real Earnings Management 36
2.1.2.3 Differences between Accrual Based Earnings
Management (AEM) and Real Earnings Management (REM)
48
2.1.2.4 Effects of Real Earnings Management (REM) 49
2.2 Corporate Governance 51
2.2.1 Concept of Corporate Governance 51
2.2.2 Regulations on Malaysian Code of Corporate Governance (MCCG)
53
2.3 Ownership Structures 57
2.3.1 Managerial Ownership 61
2.3.2 External block holder ownership 65
2.3.3 Family Ownership 69
2.4 Islamic Financial Instrument (Sukuk) 75
2.4.1 The Malaysian Islamic Capital Market (ICM) 79
2.4.2 Sukuk vs Bonds 80
2.4.3 Sukuk Issuance 83
2.5 Shariah Compliance and Political Connections 85
2.5.1 Shariah Compliance 86
2.5.1.1 Shariah Compliance and Earnings Management 90
2.5.2 Political Connection 94
2.6 Control Variables 97
2.7 Gaps in Past Studies 98
2.8 Underpinning Theories 101
2.8.1 Agency Theory 101
2.8.2 Reputation Theory 103
2.8.3 Maqasid As-Shariah Theory 105
2.8.4 Islamic Ethical Principles Theory 108
2.8.4.1 The Concept of Unity of God (Tawhid) 108
2.8.4.2 The Concept of Justice 109
2.9 Summary 109
CHAPTER 3: THEORETICAL FRAMEWORK AND HYPOTHESIS
DEVELOPMENT
3.0 Introduction 111
3.1 Theoretical Framework 111
3.2 Hypotheses Development 113 3.2.1 The Effect of Managerial Ownership on Real Earnings
Management
113
3.2.2 The Effect of External block holder ownership on Real Earnings Management
115
3.2.3 The Effect of Family Ownership on Real Earnings Management
118
3.2.4 The Effect of Sukuk Issuance on Real Earnings Management 122 3.2.5 The Influence of Shariah Compliance on the Relationship of
Ownership Structures and Real Earnings Management
127
3.2.6 The Influence of Political Connections on the Relationship of Ownership Structures and Real Earnings Management
131
3.3 Summary 133
CHAPTER 4: RESEARCH METHODOLOGY
4.0 Introduction 135
4.1 Sample and Data Source 135
4.2 Measurement of Variables 140
4.2.1 Dependent Variables 140
4.2.2 Independent Variables 143
4.2.3 Moderating Variable 144
4.2.4 Control Variable 146
4.3 Estimation Procedure (Preliminary Tests Conducted) 148
4.4 Panel Data Analysis 151
4.4.1 Static Panel Data Estimation Model 152
4.4.2 Pooled Effects vs. RE/FE 152
4.4.3 FE Model vs. RE Model 153
4.4.3.1 Feasible Generalized Least Squares (FGLS) Estimation Method
154
4.4.4 Diagnostic Test of Panel Data Analysis 155
4.4.4.1 Heteroscedasticity 155
4.4.4.2 Autocorrelation 155
4.5 Data Analysis Technique 156
4.5.1 Descriptive Statistics 156
4.5.2 Correlations Analysis 157
4.5.3 Regression Analysis 157
4.6 Regression Model 158
4.6.1 Relationship between Ownership Structures and Sukuk on Real Earnings Management
158
4.6.2 The Moderating Roles of Shariah Compliance and Political Connections on the Relationship of Ownership Structures and Real Earnings Management
160
4.7 Robustness Approach 164
4.8 Summary 165
CHAPTER 5: DISCUSSIONS AND ANALYSIS OF RESULTS
5.0 Introduction 167
5.1 Diagnostic Test 168
5.1.1 Outlier Test Analyses 168
5.1.2 Normality Analysis 168
5.1.3 Linearity Test 173
5.1.4 Panel Data Test 174
5.1.4.1 Fixed Effect vs. Random Effect Test 174
5.1.5 Heteroscedasticity Test 175
5.1.6 Autocorrelation Test 176
5.1.7 Multicollinearity Analysis 176
5.2 Descriptive Analysis 177
5.2.1 Sample Characteristics of Shariah Compliance and Political Connections
178
5.2.2 Descriptive Statistic for Dependent Variable (Real Earnings Management)
180
5.2.3 Descriptive Statistic of Independent Variables 181 5.3 Univariate Analysis of Shariah Compliance and Political Connections 183 5.3.1 Univariate Analysis of Shariah Compliance 183 5.3.2 Univariate Analysis of Political Connections 185 5.3.3 Comparison between Groups of Study Variables and Real
Earnings Management
187
5.4 Multivariate Analysis 190
5.4.1 Correlation Analysis 190
5.5 Regression Results 193
5.5.1 Ownership Structures, Sukuk and Real Earnings Management 195 5.5.2 Discussion on the Relationship between Ownership Structures,
Sukuk and Real Earnings Management
196
5.5.2.1 Managerial Ownership and Real Earnings Management 196 5.5.2.2 External Block-Holders Ownership and Real Earnings
Management
199
5.5.2.3 Family Ownership and Real Earnings Management 200 5.5.2.4 Sukuk Status and Real Earnings Management 202 5.5.3 The Moderating Effect of SC on the Relationship between
Ownership Structures and REM
205
5.5.4 Discussion on The Influence of SC on the Relationship between Ownership Structures and REM
206
5.5.4.1 The Influence of SC on the Relationship between Managerial Ownership and REM
207
5.5.4.2 The Influence of SC on the Relationship between External Block-holders Ownership and REM
210
5.5.4.3 The Influence of SC on the Relationship between Family Ownership and REM
212
5.5.5 The Moderating Effect of PC on the Relationship between Ownership Structures and REM
213
5.5.6 Discussion on The Influence of PC on the Relationship between Ownership Structures and REM
215
5.5.6.1 The Influence of PC on the Relationship between Managerial Ownership and REM
215
5.5.6.2 The Influence of PC on the Relationship between External Block-holders Ownership and REM
218
5.5.6.3 The Influence of PC on the Relationship between Family Ownership and REM
220
5.6 Control Variables 223
5.7 Robustness Test 225
5.7.1 Heteroscedasticity Test 227
5.7.2 Autocorrelation Test 228
5.7.3 Regression Analysis 228
5.8 The Summary of Results of Ownership Structures and Sukuk on Real Earnings Management and The Moderating Effects of Shariah Compliance and Political Connections on the Relationship of Ownership Structures and Real Earnings Management
234
CHAPTER 6: CONCLUSION AND RECOMMENDATIONS
6.0 Introduction 237
6.1 Overview of the Study 237
6.2 Recapitulation of Findings 240
6.3 Contributions of the Study 246
6.3.1 Theoretical Contribution 247
6.3.2 Practical Contribution 249
6.4 Limitation of the study 250
6.5 Suggestions for Future Research 251
REFERENCES 253
LIST OF TABLES
Table 2.1 Summary of difference between AEM and REM 48
Table 2.2 The principles in MCCG 2012 54
Table 2.3 Differences between Bonds and Sukuk 81
Table 2.4 Listed Shariah compliant companies 89
Table 3.1 The summary on the linkage between the stated hypothesis, objectives, and research questions
133
Table 4.1 Number of Listed Companies in Malaysia 136
Table 4.2 Initial Sample Selection Criteria 137
Table 4.3 Subsequent Sample Selection Criteria 139
Table 4.4 Summary of Measurement for Independent Variables 144 Table 4.5 Summary of Measurement for Moderating Variables 146
Table 4.6 Summary of Measurement for Control Variables 147
Table 5.1 Skewness and Kurtosis value 170
Table 5.2 Shapiro-Wilk normality test 171
Table 5.3 The Standard Deviation of the Real Earnings Management and Residuals
174
Table 5.4 Multicollinearity Diagnostic Test 177
Table 5.5 Industry classification of Shariah Compliant companies 178
Table 5.6 Shariah compliance status 179
Table 5.7 Sukuk issuance by Shariah and Non-Shariah compliant companies 179 Table 5.8 Political and Non-Political Connections Companies 180 Table 5.9 Descriptive statistics of dependent variable (REM) 180 Table 5.10 Descriptive statistics of independent variables 181 Table 5.11 Comparison of Mean Values of Shariah and Non-Shariah Firms 184 Table 5.12 Comparison of Mean Values of Political and Non-Political Companies 185 Table 5.13 T-test Analysis of REM between two groups of variables of the Study 188 Table 5.14 Pearson Correlation Matrix of the Research Variables 191
Table 5.15 195
Feasible Generalized Least Squares (FGLS) Regression Analysis on the Relationship of Ownership Structure, Sukuk and Real Earnings Management.
Table 5.16 Feasible Generalized Least Squares (FGLS) Regression Analysis:
The Moderating Effects of SC on the Relationship between Ownership Structure and REM
205
Table 5.17 Feasible Generalized Least Squares (FGLS) Regression Analysis:
The Moderating Effects of PC on the Relationship between Ownership Structure and REM
214
Table 5.18 Robustness Test using Feasible Generalized Least Squares (FGLS) Regression Analysis on the Direct Relationship between Ownership Structure, Sukuk and REM
229
Table 5.19 Robustness Test using Feasible Generalized Least Squares (FGLS) Regression Analysis: The Moderating Effects of SC on the Relationship between Ownership Structure and REM
230
Table 5.20 Robustness test using Feasible Generalized Least Squares (FGLS) Regression Analysis: The Moderating Effects of PC on the Relationship between Ownership Structure and REM
232
Table 5.21 Summary of Regression Results of Ownership Structures and Sukuk on Real Earnings Management
235
Table 5.22 Summary on The Hypotheses Testing Results of Ownership Structures and Sukuk issuance on Real Earnings Management and The Moderating Effects of Shariah Compliance and Political
Connections on The Relationship of Ownership Structures and Real Earnings Management
236
Table 6.1 Summary of the Results of Hypotheses Testing 245
LIST OF FIGURES
Figure 1.1 Global Sukuk Issuance, 2006 to 2016 (USD billion) 6
Figure 2.1: The Islamic financial systems in Malaysia 77
Figure 2.2: The top Global Sukuk Market in 2016, Malaysia International Islamic Financial Centre, MIFC and Thomson Reuters in 2016
78
Figure 2.3: Number of listed Shariah compliant companies 89 Figure 3.1: Theoretical Framework on Ownership Structures, Sukuk
Issuance, Shariah Compliance, Political Connections and Real Earnings Management.
112
Figure 5.1: Kernel Density Estimates Test 171
Figure 5.2 PNorm Test 172
Figure 5.3 QNorm Test of Normality 173
LIST OF APPENDICES
Appendix A: Summary of Statistics for Real Earnings Management
gathered by Zang (2012) 302
Appendix B: Disclosure of Interest In Securities – Section 99B
Securities Industry Act 1983; Duty of chief executive and directors 303
LIST OF ABBREVIATIONS
BNM Bank Negara Malaysia et. al (et alia); and others i.e. (id est); that is
FASB Financial Accounting Standards Boards, the United States
FE Fixed Effect
FGLS Feasible Generalized Least Squares ICM Islamic Capital Market
IFRS International Financial Reporting Standard MASB Malaysian Accounting Standard Board MCCG Malaysian Code of Corporate Governance MFRS Malaysian Financial Reporting Standards PC Political Connections
RE Random Effect
R&D Research and Development SC Shariah Compliance
Stata Statistics Anaysis Data SAC Shariah Advisory Council
SCM Securities Commission of Malaysia
1
CHAPTER ONE INTRODUCTION 1.0 Background of the Study
All companies worldwide are legislated to prepare financial statement at the end of every financial year. The accounting information disclosed in the financial statement is an important medium used by managers in communicating with the companies’ stakeholders in assessing the firm’s financial condition and earnings sustainability. The companies’ stakeholders include: the shareholders, creditors, customers, suppliers and employees. Each of the stakeholders has their own information need. For example, the shareholders assess the effectiveness and efficiency of companies’ management, the creditors want to be assured that debt covenants are not broken by the management, the customers ascertain the ability of the companies to restock goods and provide services and the employees are more concern about their job security and companies’ image (Goncharov, 2005).
In order to ensure high quality financial statement, each country has established financial reporting regulatory framework such as accounting standard, codes of corporate governance, tax laws and company laws. The financial reporting framework regulates the types, nature and timing of information to be disclosed in the financial statement. Accordingly, it is mandatory that all the parties (i.e. management, financial controller and auditors) involved in the financial reporting process reports consistently with the provisions of the regulatory framework. Thus, the financial statement will communicate the true and fair view of the company’s state of affairs. The importance of establishing regulatory framework hinge on the fact that reported earnings reflects the image of the company. Reported earnings show the operating effectiveness of management, the company’s economic realities and future prospects (Lev, 1989).
2
Given the significance of income to a company, it is no wonder that company’s management tend to lay concern in reporting process (Lev, 1989). Managers are permitted to use their discretion and expertise when reporting financial statement. However, there are existing evidences which show that the managers reporting discretion is at times abused (Roychowdhury, 2006).
As noted in prior literatures, managers manage earnings either using accrual based earnings management or real earnings management in an unethical manner for many reasons such as incentive to unduly increase their compensation package, reduce political costs, signal manager’s private information in meeting analyst forecast, beat debt covenant, avoid losses, improve credit ratings in terms of its initial public offerings, analyse seasoned equity offerings, manage buyouts, finance stock acquisitions and influence regulatory decisions (Healy, 1985;
DeAngelo, 1986; Watts & Zimmerman, 1986; Perry & Williams, 1994; Guidry, Healy &
Palepu, 1995; Holthausen, Larcker & Sloan, 1995; Burgstaher & Bichev, 1997; Teoh, Welch
& Wong, 1998a, b; Erickson & Wang, 1999; Healy & Wahlen, 1999; Kasznik, 1999; Leone &
Rock, 1999; Fields et al., 2001; Kothari, 2001).
The difference between the two approaches is that the former has no direct impact on the company’s cash flow and the later affects the current year cash flow and accrual in some circumstance1. Under the real earnings management approach, Graham et al. (2005) and Roychowdhury (2006) explain that financial executives usually exploit the real activities to earn their desired earnings, although the exploitation or control on the earnings will lower the value of the company. The activities will further reduce the value of the company because of
1 See Gunny (2010), Healy and Wahlen (1999), Roychowdhury (2006). In depth elaborations are discussed in Section 2.1.2.3.
3
the activities in that particular time will increase the earnings and will lead to negative impact on the cash flows in the future. For example, if the companies set a big discount to give to the customers as to enhance large volume of sales in short term but in the future, the customers as well expect the same thing to happen and this, may lead to small volume of sales without discount given. Additionally, managers manage companies’ earnings through hiding the real condition of the financial position and manipulate possible information needed by companies’
stakeholders (Loomis, 1999). It happens when there is a separation of ownership between the managers and companies’ shareholders that creates agency problem. Jensen and Meckling (1976) explain agency problems arise due to the maximization of managers’ wealth. As such, the separation of ownership between managers and owners provides an opportunity to mislead the information. Hence, this situation creates the rising of agency cost that will lead to inappropriate decision makings pertaining to earnings management practices (Duncan, 2001;
Johari, Saleh, Jaffar & Hasan, 2008).
Earnings management is being practiced in many countries around the world (Bhattacharya, Daouk & Welker, 2003). In Malaysia, the previous financial scandals in 1997 involving earnings management practices as one of the causes that have downturned the economy when companies’ managers are seen to be aggressively managing earnings in ameliorating financial conditions to attract investors and security brokers until the acts are led to earnings fraud (Aini, Takiah, Pourjalali & Teruya, 2006).
Regardless of the purpose and intent of managing earnings, it is well established in theory and practice that ownership structures may provide monitoring roles to corporate governance mechanisms such as such as board of directors and audit committees in curbing tendencies of unethical earnings management practices hence provide a quality financial statement
4
(Dempsey, Hunt & Schroeder, 1993; Dechow, Sloan & Sweeney, 1996; Jiambalvo, 1996). The nature of firm’s ownership structure can either exacerbate or attenuate managers’ opportunistic tendencies. For instance, concentration of ownership in the hand of few individual shareholders creates agency problem. However, institutional ownership is widely acknowledged as effective monitoring tools that can be deployed to promote good financial reporting culture among shareholders (Jensen & Meckling, 1976). Therefore, the nature of firms’ ownership structure determines the severity of agency problem.
In the Malaysian context, comments on firm’s shareholding structure revealed that majority of listed companies shares are held by government agencies, families or individuals. On the average, 73%-84% of the shares are owned by the top twenty shareholders (Kamardin, Latif &
Taufil-Mohd, 2016; Kamardin, 2014; Amran et al., 2013; Mustapha & Che-Ahmad, 2013;
Ishak, Ku-Ismail & Abdullah, 2012; Ali, Hasan & Saleh, 2007; Ishak & Napier, 2006; Abdullah
& Mohd-Nasir, 2004). A study shows that, on the average, the largest shareholder holds 36%
of the companies’ shares (Kamardin et al., 2016; Kamardin, 2014; Amran et al., 2013;
Mustapha & Che-Ahmad, 2013). In 1997, the ownership structure held by the nominee companies was 45.6% of the total shares held by the top five shareholders (Abdullah, 2001).
However, the ownership pattern has changed over time and the majority of shareholdings by the nominee companies and institutions were owned by families (Zhuang, Edwards &
Capulong, 2001). Available extant studies shows that firm’s ownership structure affects Malaysian company’s performance (Amran & Che-Ahmad, 2013: Kamardin, 2014) as well as reporting quality (Ali, Salleh & Hassan, 2008).
5
Aside the ownership structures, the institutional environment2 where the companies operate plays an important role in shaping managers’ reporting incentive. For instance, several authors such as Conroy and Emerson (2004), Kennedy and Lawton (1998), Longenecker, McKinney and Moore (2004), Noreen (1988) and Weaver and Agle (2002) highlight the role of religion in promoting ethical business behaviour. The agency contract according to Noreen (1988) is not an effective and efficient tool in curbing managers’ opportunistic behaviour. Rather, Noreen (1988) noted that the enforcement of ethical behaviour through religion functions could help in solving ethical issues in business dealings. An important tenants of the Islamic faith as enshrined in the Quran and Sunnah3 is the prohibition of the consumption and engagement in anything Haram4. Accordingly, since earnings management is resultant effect of unethical business practice, it could serve as a potential and effective tool to tame managers’ unethical behaviour.
Based on the Islamic principle of justice and fairness, it is a common practice in Malaysia for businesses to attach the halal symbol to promote their business5. As a matter of fact, the Sukuk which is an Islamic source of finance has gained prominence among other financial instruments. In the year 2017, the Malaysia International Islamic Financial Centre (MIFC) noted that many countries issued Sukuk to fund both public and private projects. In this regard, Malaysia was the largest issuer of Sukuk, followed by Gulf Cooperation Council Countries (GCC) and Indonesia which account for about 26.3 and 9.8 per cent respectively. The global Sukuk issuance over the years is shown in Figure 1.1.
2 Institutional environments are “the elaboration of rules and requirements to which individual organizations must conform in order to receive legitimacy and support” (Scott p. 132)
3 Quran and Sunnah guide the behaviour of Muslims across the world. Muslims are not expected to act contrarily to the dictates of the Al-Quran and As-Sunnah.
4 For instance the source of business finance is very important in Islam. In fact to promote halal financing the Malaysian capital market is renowned for issue Sukuk debt instrument which is considered to be an Islamic source of business finance.
5 Note that even though Malaysia is a multi-religion country, available statistics shows that approximately 19.5 million which is about 61.3% of the Malaysia population are Muslims.
6 Figure 1.1 Global Sukuk Issuance, 2006 to 2016 (USD billion) Source: Thomson Reuters, MIFC estimates
Another factor in the business environment which could influence the managers’ reporting incentive is the political environment i.e. government participation in companies’ ownership.
While it is widely argued that politically connected firms performed better compared to non- connected firms, studies show that politically connected firms increase agency cost (Chaney, Faccio & Parsley, 2011; Gul, 2006). Since the political connected firms enjoy political patronage, they tend to enjoy substantial economic benefit through special waivers and concessions from politically allies. However, the patronage can weaken corporate governance mechanisms and the quality of information disclosed. This is because the cost of non- compliance is lesser compared with the gains from politically patronage. Previous studies argued that company’s resources are deployed for the benefit of political cronies which might not necessarily be consistent with the wealth maximisation objective of the shareholders.
Accordingly, managers might have to distort accounting earnings just to hide their crony’s activities from shareholders. This is because having close ties with the political parties may not always benefit the companies since those parties have different objectives that may go against value-maximizing objectives and shareholders’ wealth maximization (Goldman, Rocholl &
Jongil, 2009).
7 1.1 Problem Statement
Earnings management is a practice indulged by managers across the globe (Bhattacharya, Daouk & Welker, 2003). The practice is either motivated by efficient contracting or opportunistic earnings management (Siregar & Utama, 2008; Scott, 2000). Subramanyam (1996), Gul, Lung and Srinidhi (2000), Krishnan (2003) and Siregar and Utama (2008) further explain that efficient contracting is able to improve earnings reporting in communicating private information. This can be proved when earnings management through accrual-based earnings management has a significant positive relationship with future profitability. However, most commonly perception on earnings management is opportunistic perspective (Millstein, 2005). For instance, Burgstahler and Dichev (1997), Balsam, Bartov and Marquardt (2002) and Kalelkar and Nwaeze (2011) reveal that although managers are given leeway to manage earnings, there will always be a temptation to inappropriately manage earnings to meet projections that suits everyone which in turn erode investors’ confidence and dent the company’s image in the long run.
With substantial evidence from series of corporate events, researches have shown that on the average, Malaysian public listed companies engage in earnings management practices (Jalil &
Rahman, 2010; Aini, Takiah, Pourjalali & Teruya, 2006; Rahman & Ali, 2006). The practices are either through accrual-based earnings management from GAAP loopholes (e.g. inventory valuation methods, depreciation among others) or real earnings management (e.g. delaying normal operating activities). The two strategies are interchangeably practiced in maintaining earnings growth (Kester, 1992; Phan & Yoshikawa, 1996; Roychowdhury, 2006; Bartov &
Cohen, 2009; Cohen & Zarowin, 2010; Gunny, 2010; Haw, Ho & Li, 2011; Zang, 2011). For instance, in 2017, Sime Darby Malaysia engaged in accrual based earnings management by charging a full-year impairment of RM684 million to its books. Same activities conducted by
8
Tat Seng Packaging Group Ltd in 2005. The company has written off of its property, plant and equipment for companies’ own missions (The Edge Market, Friday, August 25, 2017). Besides accrual-based earnings management, Digi Telecommunications Sdn Bhd in 2018 engaged in real earnings management through giving a discounted cash flow at RM5.50 to a target price of RM4.85 to increase its yearly earnings by 32% (The Star, Monday, July 16, 2018).
Hitherto, in the market studies of earnings management, most researchers tend to focus on the accrual based earnings management. This is because it is well known that managers tend to engage in accrual based earnings management techniques because it is flexible in long term, allowed by generally accepted accounting principles (GAAP) to report earnings which can meet or beats the consensus analyst forecast on economic performance, lower cost incurred, lower taxable income and lower financial distress (Healy & Wahlen, 1999; Scott, 2000; Barton
& Simko, 2002; Zang, 2012). Besides, it is noted that the real earnings management is hard to detect when managers change the companies underlying operations since it involves timing or structure difference from the actual business activities in terms of incurring a higher cost, higher taxable income and higher financial distress. Real earnings management also may affect companies’ short term or current year cash flow (Rahman & Ali, 2006; Roychowdhury, 2006;
Gunny, 2006; Jalil & Rahman, 2010; Zang, 2012; Rahman, Sulaiman, Fadel & Kazemian, 2016). Additionally, in some instances, the real earnings management practices could be due to “just business” motive and not for unethically purposes or personal interest. Therefore, it is difficult to differentiate between the normal business activity with company’s intention to manage earnings and profitability. The “just business” motive suggests that restructuring charges accompanied by REM, are indicative of managerial efforts to improve the long-term profitability. It is revealed that future sales growth is associated with changes in sales and overproduction. Besides, the departure from normal levels of production coupled with positive
9
sales growth is evidence of managers using resources more efficiently and not a signal of earnings management (Paredes & Wheatly, 2017). Although the real earnings management practices are still at the infancy stage, managers nowadays tend to switch the former to latter strategy (Paredes & Wheatly, 2017: Zang, 2012; Roychowdhury, 2006). Thus, this study attempts to extend prior study on earnings management by examining the real earnings management as a less commonly studied earnings management proxy.
The issue of real earnings management is complicated compared to accrual based earnings management. This is due to difficulty in detecting it compared to accrual-based earnings management which has stricter IFRS implementation to prevent the practices (Zhao, Chen, Zhang, & Davis, 2012; Feldmann & Khanh-Le, 2017). Graham et al. (2005) report that most CFOs engage in real earnings management practices through decreasing the cost of research and development, advertising as well as maintenance expenditures (Roychowdhury, 2006;
Cohen et al., 2008; Bartov & Cohen, 2009; Cohen, Mashruwala & Zach, 2010; Ibrahim et al., 2011; Kang & Kim, 2012). For instance, R&D has its own measurement on its cost in terms of the accounting treatment. The International Financial Reporting Standard (IFRS) under IFRS 138 explains that there are two approaches in treating R&D cost. The approaches in measuring the cost are either to disclose it as capitalized amount (an asset) for the companies or to expense it. The R&D choice creates the earning management practices (Osma, 2008). In Malaysia, standard setters allow the companies to capitalize the cost of development as long as the cost is able to meet the specification stated and must treat the research costs as expense (Taufil, Latif, Hussin, Bakar & Ismail, 2006). Since real earnings management activities are beyond the rules and regulations of the existing accounting and auditing procedure, the controlling and monitoring process by external parties are limited to restrict managers to engage in real
10
earnings management6 compared to accrual based-earnings management (Kim & Sohn, 2013;
Zang, 2012, Cohen & Zarowin, 2010; Roychowdhury, 2006; Dechow, Sloan & Sweeney, 1996).
So far, previous studies have examined several determinants of real earnings management (Zang, 2012; Cohen & Zarowin, 2010; Roychowdhury, 2006; Graham et al., 2005; Hribar et al., 2004; Skinner & Sloan, 2002). These researches on real earnings management are conducted in developed markets7 such as United Kingdom, Canada and United States. The determinants that lead companies in Malaysia to engage in real earnings management are deemed to vary from those companies in developed market because Malaysia is an emerging market8. This is due to legal protection of outside shareholders and market for corporate control is weaker in emerging market compared to developed market, thus the issue of earnings management is more prevalent (Bebchuk, 1999; Burkart, Panunzi & Shleifer, 2003). To date, there are few studies examining real earnings management in Malaysia and considered lacking of conclusive evidence. The studies only focus on some part of ownership structure characteristics (Olayemi, 2013). Therefore, this study attempts to study in details the relationship between various ownership structures and earnings management.
6 REM can be engaged through; (i) giving discounted price to boost in sales temporarily, (ii) reducing in discretionary expenses to refine companies’ margin and (iii) overproduction to disclose small value of cost of goods sold in order to avoid losses in its short term cash flows
7 Developed markets are market in the countries that have the most advanced economically. As well, they have highly developed capital markets with high levels of liquidity, meaningful regulatory bodies, large market capitalization, and high levels of per capita income. Developed markets are found mostly in U.S., Canada, Germany, the U.K., Australia, New Zealand and Japan. (Source: www.nasdaq.com)
8 Emerging markets are market in the countries in the process of rapid growth and development with lower per capita incomes and less mature capital markets than developed countries. It includes Malaysia, Indonesia, Thailand, Brazil, Russia, India, and China. (Source: www.nasdaq.com)
11
In order to restore integrity and confidence on earnings reporting as well as reducing earnings management, corporate governance acts as one characteristic that prevent and curb malfeasant practices (Malaysian Code of Corporate Governance, 2016). However, recently the Malaysian Securities Commission (2015) reports that there are still weaknesses in the existing companies’
corporate governance. Evidence gathered from past studies reveal that different ownership structures have a different impact on the corporate governance in monitoring earnings management activities (Cheung & Chan, 2004; Klein, Shapiro & Young, 2005; Machuga &
Teitel, 2009; Swai & Mbogela, 2016). Wang (2006) and Swai and Mbogela (2016) further add that ownership structures such as insiders (managerial ownership), institutional investors, block-holders and family ownership (concentrated ownership) give significant effect on earnings reporting.
It is argued that ownership structures could either reduce or increase reporting quality. This is due the arguments on the alignment and entrenchment effect which provide contradicting predictions about the effect of ownership structures on reporting quality (Jensen & Meckling, 1976; Fama & Jensen, 1983b; Morck, Shleifer & Vishny, 1988). Shareholders are residual claimant and have no direct control over the management when it comes to decision making.
The separation of ownership from control will therefore lead to agency problem (conflict of interest) among both parties. Managers will be more interested in acting in manners contrary to expectation that they protect shareholders interest. Managers could distort the financial statement and creates agency conflict (Jensen & Meckling, 1976; Lemmons & Lins, 2003;
Kamardin, 2014). On the other hand, ownership structures in some instance could serve as monitoring mechanisms which can reconcile the difference between owners and the shareholders and may reduce agency problems and therefore improve reporting quality (Jensen
& Meckling, 1976; Morck, Shleifer & Vishny 1988; Amran & Che-Ayoib, 2013). As most of
12
the previous studies tend to focus on the impact of earnings management that have concentrated largely using discretionary accrual as a proxy for earnings management, this study is hoped to contribute to the discussion issue of real earnings management through identifying the characteristics that may influence or mitigate real earnings management. Therefore, this study creates opportunities to close the gap in answering the effect of ownership structures on real earnings management.
In discussing about ownership structures, it is found that managerial ownership is the utmost important factor in assessing companies’ reporting behaviour (Mustapha & Che-Ayoib, 2011).
This is because managerial ownership is seen to have a large percentage of shares in the companies in Malaysia as compared to other shareholders group (Kamardin, 2014; Amran &
Che-Ayoib, 2013; Mustapha & Che-Ayoib, 2011). Various gaps and issues are identified in determining this variable. Importantly, most of past studies focus on investigating managerial ownership on companies’ performance such as studies conducted by Kamardin (2014), Amran and Che-Ayoib (2013) and Mustapha and Che-Ayoib (2011). Additionally, there are studies pertaining to the relationship between managerial ownership and earnings quality, but the studies are concentrated on accrual based earnings management and neglecting real earnings management practices. The studies are such as Gul et al. (2003), Ali, Salleh and Hassan (2008), Yang, Lai and Tan (2008) and Alzoubi (2016). Lastly, with regards to the results gathered from previous studies on earnings quality, the outcomes are somewhere mix and inconclusive. For example, Fama (1980), Fama and Jensen (1983), Weisbach (1988), Jung and Kwon (2002), Denis and McConnell (2003), Gul et al. (2003), Cheng and Warfield (2005), Peasnell et al.
(2005), Yang, Lai and Tan (2008), Al-Fayoumi, Abuzayed and Alexander (2010) and Mitani (2010) conclude a positive relationship between managerial ownership and earnings quality.
However, Nia, Sinnadurai, Sanusi and Hermawan (2017), Alzoubi (2016), Alves (2012),
13
Habbash (2010), Banderlipe (2009), Ali, Salleh and Hassan (2008), Ebrahim (2007), Iturriaga and Hoffmann (2005), Patten and Trompeter (2003), Klein (2002), Warfield et al. (1995), Watts and Zimmerman (1986) and Dhaliwal, Salamon and Smith (1982) reveal a negative relationship between managerial ownership and earnings quality. Thus, in addressing the gaps and the issues that arise will be the opportunity for this study to provide evidences on the relationship between managerial ownership and earnings quality through real earnings management.
Next, another type of ownership structure is external block-holders ownership. Basically, external block-holders lend its effectiveness to motivate and direct the companies which they have invested (Gabrielsen et al., 2002; Yeo et al., 2002; Shleifer & Vishny, 1997). This indicates that the larger the shareholdings, the higher the inclination to increase companies’
value which will later compromised companies’ financial reporting quality (Boubakri et al., 2005; Shleifer & Vishny, 1997; Fama & Jensen, 1983; Fama, 1980; Jensen & Meckling, 1976).
However, in some instances, small shareholders will not be concerned with monitoring since they would have to tolerate the costs of monitoring, thus they only take part in a small portion of the welfare (Zhong et al., 2007). Previous studies found that external block-holders ownership influenced companies’ performance and financial reporting quality (Jensen &
Meckling, 1976; Fama, 1980; Fama & Jensen, 1983; Beasley, 1996; Shleifer & Vishny, 1997;
Bhagat & Black, 2002; Klein, 2002; Yeo et al., 2002; Boubakri et al., 2005; Wang, 2006;
Mohd-Ali, Hassan & Mohd-Saleh, 2007; Kang, 2008; Hashim; 2009; Ishak, Ku-Ismail &
Abdullah, 2012). Also, these studies focus mainly on accrual based earnings management as proxy in measuring financial reporting quality. Investigation on real earnings management practices is considered to be limited and need for further clarification. Thus, it is hoped that this variable may contribute more knowledge on real earnings management.
14
Apart from managerial and external block-holders ownership, family ownership is another type of ownership structure that might impact the real earnings management practices. There are bulk of studies examining the relationship between family ownership and earnings quality.
Nevertheless, those studies focus on accrual based earnings management as a proxy for earnings quality limiting the result of real earnings management. The studies are such as Ali et al. (2007), Castaneda (2007), Siregar and Utama (2008), Jiraporn and DaDalt (2009), Wan Ismail (2011), Bona-Sanchez et al. (2011) San Martin-Reyna and Durban-Encalada (2012).
Additionally, it is noteworthy that family ownership structure has an inconclusive relationship with earnings quality. In some circumstances, past studies conclude that family ownership may enhance companies’ performance and financial reporting quality (Fama & Jensen, 1983;
Demsetz & Lehn, 1985; Fleming, Heaney & Rochelle, 2005; Jaggi et al., 2009; Jiraporn &
DaDalt, 2009; Bona-Sanchez et al., 2011; Amran & Che-Ayoib, 2013; Kamardin, 2014). There are also studies that report a reverse outcome; family ownership leads to earnings management (Fama & Jensen, 1985; Schulze, Lubatkin, Dino & Bucholtz, 2001; Ali et al., 2007; Castaneda, 2007; Prencipe et al., 2008; Siregar & Utama, 2008; Yang, 2010). As such, this study attempts to add more ideas on real earnings management and reveal the effect of family ownership and real earnings management.
Another area of interest in the present study is the financial instrument role in determining the reporting incentive of management. When raising more capital through the issuance of financial instrument like bond, managers rely on discretion and prospective information in reporting earnings. A number of evidences exist in this regard such as Cohen and Zarowin (2010), Pae and Quinn (2011) and Kamel (2012) which suggest that managers manipulate earnings through financial instruments issuances. Next, Graham et al. (2005); Kim and Sohn, (forthcoming); Roychowdhury (2006) established a relationship between bond issuance and
15
earnings management in the sense that bondholders are interested in future cash flow and the ability of the firm to repay principal and pay interest. Accordingly, this provides an incentive for the managers to manage earnings and therefore reduce the financial reporting quality.
Interestingly, the present study tends to depart from prior studies by obtaining further evidence on the effect of Islamic debt instrument (Sukuk) on managers reporting incentive. In Malaysian capital market, there are several numbers of Shariah and non-Shariah compliant companies in Malaysia which issue Sukuk to raise capital (Bursa Malaysia, 2016). Sukuk is considered special when credit rating agencies could provide information that relates to the creditworthiness of issuers, which aims to reduce the information asymmetries between issuers and investors by providing information on the rating (Arundina et al., 2015). The Malaysian Credit Ratings Agencies (MCRA) further rates Sukuk to add to its credibility (Ahmed et al., 2014). Consequently, governance mechanisms are significantly related to credit rating (Bradley et al., 2007). As such, Sukuk issuance represents companies’ good value and become a key function of information transmission in the capital market by representing the undivided shares in ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity (AAOIFI, 2010, p. 307). To the best of the authors’ knowledge, there is dearth of literature on the relationship between Sukuk and earnings management in Malaysia. Therefore, this study attempts to address the gaps regarding Islamic financial instrument which could probably provide benchmarks that the managers’
opportunistic behaviour to engage in real earnings management is less prevalence.
Further, moderating roles also could provide possible explanation on the direction of an effect between independent variable and dependent variable (Baron & Kenny, 1986). There are
16
various requirements for a variable to be a moderator. For instance, acknowledgment of the complexity of behaviour, manipulation check, generalizability of results, specificity of effects, identification of effect in subgroups, investigation of lack of an intervention effect, as a test of theory, measurement improvement and practical implications (MacKinnon, 2011; Baron &
Kenny, 1986). Thus, this study has two moderating variables; Shariah compliance and political connections which are believed to fulfil the stated moderating variables’ requirement which will further affect the relationship between ownership structures and real earnings management. As for Shariah compliance, it represents a unique attribute of the firm with low leverage, low account receivables and low cash which may provide lower chances for managers to engage in accounting misbehaviour (Farooq & AbdelBari, 2015) while political connections represent a proxy where companies that are under pressures will disclose lower financial reporting quality (Chaney, 2009).
Shariah compliance has grabbed attention of many companies since Malaysia is seen as a unique and progressive Islamic state that it is acknowledged by many other Muslim countries that follows Islamic law (shariah) in daily life as well as in business transactions. The Islamic law is mandated to enhance Muslim investors’ confidence and assist Malaysia to become an international centre for Islamic Capital Markets that trades Shariah-compliant investments (Securities Commission, 2006). Business that complies with the Islamic law derives their ethics from the divine commandment sourced from Al-Quran and Sunnah. The important values preached are justice and unity of God. Muslim believers regard compliance with these values as parts of faith (Haniffa & Hudaib, 2002; Alhabshi, 1987). Shariah compliance companies are likely going to avoid unethical earnings management (Ibrahim, 2000; Lewis, 2001; Dadgar &
Naderi, 2009; Hua, 2009; Abdul-Rahman et al., 2012; Alkdai & Hanefah, 2012; AbdelBari, 2015; Wan Ismail, Kamarudin & Sarman, 2015). Thus, it is believed that Shariah compliant
17
companies will further enhance good quality of reporting. However, study on Shariah compliance and earnings management among Malaysian companies is still lacking (Wan Ismail et al., 2015) and to the best of the researcher’s knowledge, there is lack of study that examines the influence of Shariah compliance on the relationship between ownership structure characteristics and real earnings management. Therefore, the present study proposes that the relationship between ownership structure and real earnings management could be moderated by Shariah compliance. As such, it is believed that Shariah compliant companies reporting will be consistent with the Islamic values of justice that forbids people to engage in exploitation and injustice activities that may harm one and another such as the intolerance between principal-agent relationship, fraudulent business transaction and bias debt covenant/ debt contract activities (Securities Commission, 2009d).
Lastly, Malaysia is a country where corporate sector is dominated by politically favoured companies (Gul, 2006). Firms’ political connectedness has been widely discussed to have serious consequence on financial reporting quality. Previous studies revealed that political connected companies tend to engaged in unethical earnings management for the purpose of concealing their cronyism activities (Watts & Zimmerman, 1990; Faccio, 2006; Faccio et al., 2006; Chaney et al., 2011).
In addition, gaps can be identified when study on political connected firms in Malaysia builds on Gomez and Jomo (1997) that examined firm political connectedness and firm performance over 20 years ago. Meanwhile, Wahab, Zain, James and Haron (2009) conduct a study on institutional investors, political connections and audit quality but not the earnings quality.
Recently, Al-Dhamari and Ku Ismail (2015) conduct a study measuring the relationship between political connections and earnings quality with data collection ranging from 2007 until
18
2011 on the top 100 Malaysian listed companies. Findings from all the mentioned studies show that political connected firms are associated with low earnings quality. Hence, the present study tends to extend investigations on political connection by considering its effect on the relationship between ownership and real earnings management. To date there is no study that examines the influences of political connections on relationship of ownership structure characteristics and real earnings management.
1.2 Research Questions
Research question is the inquiry that is answerable pertaining to related subject matters. The research questions are set as follows:
1. Do ownership structures give effect on real earnings management among Malaysian companies?
2. Do sukuk issuance gives effect on real earnings management among Malaysian companies?
3. Does Shariah compliance moderate the relationship between ownership structures and real earnings management among Malaysian companies?
4. Do political connections moderate the relationship between ownerships structures and real earnings management among Malaysian companies?
1.3 Objectives of the Study
This study conducts an investigation to answer the questions pertaining to the relationships of ownership structures and sukuk issuance on real earnings management among Malaysian companies. The study also investigates the relationship of ownership structures and real earnings management with the influence of Shariah compliance as well as political connections respectively. Thus, the objectives of this study are:
19
1. To examine the effect of ownership structures on real earnings management.
2. To examine the effect of sukuk issuance on real earnings management.
3. To examine the moderating roles of Shariah compliance on the relationship between ownership structure characteristics and real earnings management.
4. To examine the moderating roles of political connections on the relationship between ownership structure characteristics and real earnings management.
1.4 Significance of the Study
The issue of earnings management remains an area of interest to accounting practitioners, academic researchers and policy makers worldwide. This is because earnings management is being practiced across the globe and are considered alarming which in few instances erode investors’ confidence. Considering Malaysia as one of the countries with no exception in engaging in this practice, most researchers in market studies tend to focus on the accrual based earnings management with little attention on the real earnings management. One of the reasons is because real earnings management is still at infancy in the area of study (Abdul-Rahman &
Ali, 2006; Roychowdhury, 2006; Jalil & Rahman, 2010; Rahman, Sulaiman, Fadel &
Kazemian, 2016).
Consequently, most researchers use Roychowdhury’s model as proxy in examining real earnings management activities. Interestingly, Zang (2012) modifies the activities involved by considering the abnormal cash flow from operation (ACFO) to be different from one industry to another industry that cause the end result to be ambiguous. Thus, this study will shed more lights underlying on modified model suggested by Zang (2012) in measuring real earnings management activities.
20
Besides, in restating confidence and integrity on earnings reporting, corporate governance mechanisms are believed to prevent and curb malfeasant practices (MCCG, 2016).
Nevertheless, there are specific corporate governance mechanisms that affect reporting quality (Haniffa & Cooke, 2002) and to date, past studies associate companies’ corporate governance mechanisms with the board and audit committee characteristics limiting the studies on ownership structure characteristics. Importantly, questions always come across when it is argued that ownership structures could either reduce or increase reporting quality (Jensen &
Meckling, 1976; Morck, Shleifer & Vishny 1988; Lemmons & Lins, 2003; Amran & Che- Ayoib, 2013; Kamardin, 2014).
Another possible elixir that is believed to curb malfeasant practices in this study is the institutional environment in terms of the role of religion in promoting ethical business behaviour. In this case, it is believed that Sukuk as one of the financial or debt covenants same as bond but it complies with Shariah (Islamic law) which could provide benchmarks that the managers’ opportunistic behaviour to engage in real earnings management is less prevalence.
To the author’s knowledge, this variable is considered new since there is no study examining on the relationship of Sukuk issuance and real earnings management. Therefore, it is important to gather the end result of this relationship in order to contribute more ideas and can highlight the areas that require improvement and further clarification.
Next, two moderators are presented in this study. First is Shariah compliance and second is political connection. Shariah compliance is able promote role of religion in ethical business behaviour. To the best of the researcher’s knowledge, there is no study that examines the effect of Shariah compliance on the relationship between ownership structure characteristics and real
21
earnings management. Therefore, it is believed that Shariah compliant companies reporting will be consistent with the Islamic values of justice.
Another factor that could badly influence the managers’ reporting incentive is the political environment i.e. government participation in companies’ ownership. Political connections are believed to weaken corporate governance mechanisms and affect quality of information disclosed (Chaney, Faccio & Parsley, 2011; Gul, 2006). This factor is considered to be highlighted when lots of cases pertaining to it are revealed and it associates to low earnings quality. Interestingly, hitherto, there is no study that examines the influences of political connections on relationship of ownership structure characteristics and real earnings management.
Thus, this research hopes to extend contributions to the literature on earnings management, ownership structures, sukuk issuance, Shariah compliance and political connections from the theoretical, practical and methodological perspectives. In line with the mentioned argument, the contributions of this study are twofold, namely, theoretical and practical contributions.
1.4.1 Theoretical Significance
This study examines the relationship between ownership structures and sukuk issuance on real earnings management by testing the effect of selected institutional qualities such as Shariah compliance and firm political connection. The issues raised in the present study are of interest because academic researchers, policy makers and accounting practitioners continue to raise serious concern about the quality of reported earnings. Worldwide, poor reporting quality has always being attributed to firms’ collapse. Since Malaysia is part of the global village, conducting a research in this area is of great significance.
22
Although several studies have being conducted on reporting quality, the focus is much restricted to the accrual based earnings management with less consideration for the real earnings management practices (Abdul-Rahman & Ali, 2006; Jalil & Rahman, 2010; Rahman, Sulaiman, Fadel & Kazemian, 2016). To the author’s knowledge, previous empirical researches examined few factors that cause real earnings management practices separately or combined at a single time (see for example, Abdul-Rahman & Ali, 2006; Roychowdhury, 2006;
Cohen, 2008, Jalil & Rahman, 2010; Rahman et al., 2016). Through determining one or two characteristics at a single time maybe limiting the potential effects of another significant characteristic that lead the managers to engage in real earnings management practices. The present study scrutinizes the important determinant of real earnings management, which is corporate governance mechanism via ownership structure; (1) managerial (2) external block- holders (3) family and sukuk issuance. It is expected that the influx of new determinants i.e.
ownership structures and sukuk issuance may give significant impact on real earnings management. Thus, these will address the gap on the present findings and contribute to the existing knowledge and theory.
Additionally, this study introduces moderating characteristics that might influence the association of the independent determinants and real earnings management practices. The first moderating variable is shariah compliance. The study on shariah compliance and earnings management among Malaysian companies is still lacking and considered as a variable that might mitigate earnings management (Ibrahim, 2000; Lewis, 2001; Dadgar & Naderi, 2009;
Hua, 2009; Alam & Rajjaque, 2010; Alkdai & Hanefah, 2012; Abdul-Rahman et al., 2012;
Wan Ismail et al., 2015; AbdelBari, 2015). As such, this variable is hoped to contribute new knowledge pertaining to the influence of Shariah compliance on the relationship of ownership
