Earnings Management and Fraudulent Financial Reporting: The Malaysian Story

Abstract

Earnings management research has a long and rich history. The agency conflict, incentives, rationalization, opportunity plus having the capability among the managers to manipulate the financial statements lead them to commit fraud. The loopholes in the standards or the deviation from real operational activities promote this situation to prolong. In relation to this issue, this study examines the earnings management behavior among fraud firms in Malaysia. Further, this study examines the relationship between accruals earnings management as a proxy variable for discretionary accruals and real earnings management as the proxy variable for discretionary cash flow. Sample of 57 alleged fraud firms was selected based on the fraudulent financial reporting offences announced in Bursa Malaysia website. The sample data are collected from public firms which committed fraud from 2001 to 2013. This study found a significant negative relationship between accruals earnings management and real earnings management among the fraud firms in Malaysia suggesting that these firms aggressively manage earnings downwards or upwards essentially to avoid regulators scrutiny apart from aiming to achieve personal incentives. The study significantly finds evidence that fraud firms manage earnings on a sequential basis between accruals earnings management and real earnings management prior to fraud year. The findings indicate that firms opt for real earnings management and make full use of its distinguished features of not easily traceable to continue managing earnings immediately subsequent to fraud year. This study may assist regulators, auditors, and policymakers to curb earnings management patterns that have high likelihood of becoming part of fraud antecedent.

Concealing Financial Distress With Earnings Management: A Perspective on Malaysian Public Listed Companies

“…The average financial distress score also showed an increase from -5.20 to -8.42, which may mean increase in the level of severity by companies facing financial distress in 2017, despite the number of companies with financial distress condition from the sector remains stagnant in both years. Hence, Malaysian companies listed on the Industrial Product sector experienced financial distress condition in line with the findings by Aghghaleh et al (2016); Agrawal and Chatterjee (2015); Ghazali et al (2015); Hassanpour and Ardakani (2017); Kazemian et al (2017); Mohammadi and Amini (2016); Nagar and Sen (2016); Quy and Nhan (2017); and Rahman et al (2016).…”

“…The size of a firm is determined based on the capital utilised by the company to generate income as it determines the limit and extent by the firm in allocating its resources for generating its income (Dang et al, 2018;Mohammadi & Amini, 2016;Rahman et al, 2016). The measurement of the firm"s size in this study will be the "Total Assets" as it is widely used in most academic researches (Dang et al, 2018).…”

“…This is excess cash after all the operating expenses and obligations have been paid by the company and it comes from the revenues that the company generates through their operation activities. It is the total operating cash flow and this amount does not affect the operation of the companies as it is an idle amount kept (Humeedat, 2018;Mohammad, Bassam, Maali, & Al-Attar, 2017;Qin & Ren, 2017;Rahman, Sulaiman, Fadel, & Kazemian, 2016).…”

“…Earnings management is defined as intervention by the company"s management via earning adjustment by utilising accounting techniques on financial statements to meet specific targeted outcome (Dechow & Skinner, 2000;Dechow, Sloan, & Sweeney, 1995;Ghazali et al, 2015;Schipper, 1989). Furthermore, cases of earnings manipulation also took place among public listed companies on Bursa Malaysia (Ghazali et al, 2015;Rahman, Sulaiman, Fadel, & Kazemian, 2016;Sadique, 2016).The main drive for earnings management can be explained by using Agency Theory argument as posed by Jensen & Meckling (1976). For instance, in line with fulfilling shareholders expectations on financial performance while securing their position and interest within the company, management may be influenced to engage earnings management when the actual financial outcome is in financial distress.…”

Earnings Management and Fraudulent Financial Reporting

“…Earnings management actions can arise from agency friction, particularly when management wants to maximize personal gain or pressure to provide quality financial information to company shareholders. However, when the pressure to achieve profit targets increases, earnings quality is no longer a priority, but is replaced by personal gain which often leads to fraud (Rahman et. al., 2016).…”