The Association between Related Party Transactions and Real Earnings Management: Internal Governance Mechanism as Moderating Variables

Abstract

'(& (We investigate the association between related party transactions (RPT) and real earnings management (REM). We also investigate the role of internal governance mechanism through the effectiveness of board of commissioner and audit committee in mitigating the association between RPT and REM. Our research sample consists of 386 firm-years of manufacturing firms listed in Indonesian Stock Exchange (IDX) from year 2010 -2014. Using linear regression, we find evidence that RPT has positive association with REM, only when the firm has higher RPT but not in the lower RPT. We find a contradictory result that board of commissioners strengthen the positive association between RPT and REM. Finally, we find evidence that the effectiveness of audit committees weaken the positive association between RPT and REM, both in full sample and in high RPT sample.

Related Party Transactions, Family Ownership, and Earnings Management in Indonesia

“…This test supports hypothesis 1, which indicates that related party transactions lead to transactions that improve accrual earnings management practices. This result is consistent with various previous studies, which show that related party transactions have a significant positive effect on corporate earnings management practices (Haji-Abdullah & Wan-Hussin, 2015;Limanto & Herusetya, 2017;Rahmat et al, 2020). Regression model 2 shows that the family ownership structure has a positive effect on accrual earnings management.…”

“…In line with research conducted by Rahmat et al (2020), related party transactions are used opportunistically by controlling shareholders to manipulate earnings on an accrual basis, even more, because of low investor protection, thus reducing the quality of earnings generated by the company. Limanto & Herusetya (2017) also state that manufacturing companies in Indonesia that have transactions with related parties higher than their total sales transactions have a close relationship with earnings management practices through their real activities. The company's shareholders, who come from families, are increasingly abusing transactions with related parties.…”

“…Although El-Helaly et al (2018) revealed that there is no systematic relationship between related party transactions and accrual earnings management, there is a possibility that related party transactions are used as a substitute for real earnings management. Limanto & Herusetya (2017) stated that related party transactions carried out by companies escalate the earnings management practice in Indonesia. However, other research in Indonesia shows that related party transactions do not affect earnings management practices because they may be used appropriately and efficiently (Suryani et al, 2019).…”

“…The inconsistency of those researches about related party transactions on earnings management encourages other research to added several moderating variables such as audit quality (El-Helaly et al, 2018), women as part of the audit committee board of directors (Jalan et al, 2020), mechanism of good corporate governance (Mita & Utama, 2015;Limanto & Herusetya, 2017;Marchini et al, 2018a), and family ownership structures or corporate, institutional ownership structures in Malaysia and Jordan (Haji-Abdullah & Wan-Hussin, 2015;Alhadab et al, 2020).…”

Related party transactions and earnings management in Jordan: the role of ownership structure

“…Literature on related party transactions identified the potential for negative use of such transactions, referring to that use as "tunneling." This case involves the use of related party transactions by controlling shareholders to expropriate funds from the firm to themselves at the expense of minority shareholders (Johnson et al, 2000;Utama and Utama, 2009;Chen et al, 2011;Williams and Taylor, 2013;Kang et al, 2014;Boateng and Huang, 2017;Habib et al, 2017a;Limanto and Herusetya, 2017;Abdul Rasheed and Mallikarjunappa, 2018;El-Helaly, 2018). Some methods of performing such transactions include transfer pricing, selling assets for profit, issuing securities to related parties for a low price and making excessive payments to executive managers, typically family members of the controlling owners (Utama and Utama, 2009).…”