Islamic Finance and Its Role in Economic Development and the Creation of Just and Stable Financial System in Light of Maqosid Syariah
UIN Sunan Kalijaga Yogyakarta 12th – 14th November 2014
The Implementation of Islamic Good Corporate Governance (GCG) on The Compenies Listed in The Jakarta Islamic Index (JII) to Decrease Earning
Management Practices
Edy Suprianto Rudi Abdillah
Abstract
Earning Management is a management action to control some earnswhich are appropriate with management desire to gain individual profit. Good corporate governance needs to decrease it because some companies in Jakarta Islamic Index will not usually do the earnings management. In many studies, it has been detected that there are many factors such as leverage, ownership concentration, firm size, and good corporate governance influencing earnings management practices. This study tries to investigate the influence of leverage, ownership concentration, firm size and good corporate governance toward earnings management practices.
The corporate governance of this research is composition of the board of directors and audit quality. The Quality audit is measured by audit firm size and audit committee.
The type of this study is a descriptive quantitative. The targeted population is the companies listed in the Indonesian Stock Exchange and the Jakarta Islamic Index. The sample is determined by purposive random sampling method. There are 130 companies meeting the criteria. The Data analysis is carried out in terms of financial statements in the range of 2004 to 2008. The Hypotheses of this study are tested by using multiple regression analysis. The data Collection technique is through documentation.
The findings of this study show that on average, there are some companies listed in the Jakarta Islamic Index implementing earnings management practices even though the value is very low. Leverage has a positive influence toward earnings management.
However, ownership concentration has no influence toward earnings management, the company size has a negative influence toward earnings management; the composition of the board of commissioners, audit firm size and the audit committee have no significant influence toward earnings management.
Keywords: Leverage; Ownership concentration; Company size; Composition of the board of commissioners; Audit firm size; Audit committee;
Earning management
1. Introduction
Financial Statement is a medium of communication that is used to connect the parties having interest with the company. The financial statement is a means to account for what is done by the managers toward the existing resources. One of the important parameters in financial statements used to measure the performance of management is earning. Earning information as a part of the financial statements often becomes a target of manipulation through management actions to maximize their satisfaction. Such action is done by selecting certain accounting policies, so that corporate profits can be set, increased or decreased in accordance with management desires. Management behavior to regulate earning in accordance with the wishes and desires of management is known as earnings management.
The Jakarta Stock Exchange (JSX) in cooperation with PT. DanareksaInvestment Management (DIM) in 2000 had launched the Jakarta Islamic Index (JII) as the movement of share prices of listed companies that are categorized in accordance with the principles of sharia in Indonesia. The purpose of the Islamic index as the Jakarta Islamic Index (JII) done by involving 30 selected stocks is as a benchmark to measure the performance of investments in Shariah-compliant stocks and increase the confidence of investors to develop investment in Shariah ways, as well as provide an opportunity for investors who want to do investments in accordance with Islamic principles. These facts attract the researcher’s interest because there are 30 companies in the Jakarta Islamic Index (JII) which according to the national Sharia Board (DSN) meet the Islamic principles. Basically, the companies included in the Jakarta Islamic Index (JII) are the conventional companies that meet the requirements of the BAPEPAM and DSN. In common, these companies will not do earnings management practices.
This study tries to combine several independent variables contained in the three studies above, in terms of its influence on Earnings Management. The variable of the Ownership Concentration, Company Size and Composition of the Board of Commissioners as a Mechanism of Good Corporate Governance (GCG) are at Nuryaman study (2008), while the Leverage variables is at the study by Tarjo (2008); and the variable of the public accounting firm size, the Audit Committee as a mechanism of Good Corporate Governance (GCG) are on the study by Veronica and Siddharta (2005). Moreover, the research object in this study is the companies listed in the Indonesian Stock Exchange (BEI) and the Jakarta Islamic Index (JII).
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Based on the description above, the researcher seeks to examine the influence ofLeverage, ownership concentration, company size, andgood corporate governancemechanisms toward the earnings management of the go publiccompanieslisted in the Indonesian Stock Exchange (BEI).
2. Literature Review 2.1 Agency Theory
Agency theory is the basic theory underlying the company's business practices nowadays. This theory states that there is a correlation between the parties authorized (principal), the investor; and the party receiving authority (agency), the manager, in the form of a contract of cooperation. According to Elqorni (2009), agency theory assumes that all individuals act on their own interests. The principal as shareholder is assumed to be only interested in increasing their financial results or their investments in the company.
Meanwhile, the agent is assumed to just receive high satisfaction in the form of financial compensation and the terms accompanying such correlations.
The activities undertaken by the agent may have an impact on the value of assets in the Balance Sheet in order to "beautify" the financial statements even though at the not actual values. Moreover, they could also perform income smoothing (divide profits into another period), so that the company seems to obtain profit every year, while in fact they suffer a loss and profit decrease.
2.1.1. Good Corporate Governance
According to the Forum For Corporate Governance in Indonesia (FCGI), the definition of good corporate governance is a set of rules governing the relationship among shareholders, management of a company, creditors, government, employees; and the internal and external stakeholders having rights and obligations within a company, or in other words it is a system that regulates and controls the company.
Besides that, FCGI also explains that the purpose of corporate governance is" to create added value for all interested parties (stakeholders)”. In more detail, the terminology of Corporate Governance can be used to explain the role and conduct of the Board of Directors, the Board of Commissioners, trustees (managers) of the company, and the shareholders.
2.2 Earning Management
Earning management is a phenomenon that is difficult to be avoided because this is the impact of the use of the accrual basis in preparing financial statements. Practically, the managers can select accounting policies appropriate with the accounting standards. Therefore, it is reasonable that managers choose policies to optimize their utilities and the market value of the company. This is what Scott (2003:368-369) in Tarjo (2008) called as earnings management. Thus, earnings management is the accounting policy chosen by the manager to achieve certain goals.
2.3 Hypotheses Development
Debt Policy Investigation by Ahmad et al. (2007) shows that the increasing motivation of the debt agreement (debt covenant) will increase the earnings management practices. The reason is that earnings management is regarded as something worth to be done by the manager, because the company is motivated to seek funding and impressed to have difficulty in selling its shares in the stock market. So, the first hypothesis proposed in this study is :
H 1: leverage has a positive influence toward Earnings Management practices.
In general, most shareholders hand in their investment management to a special division by appointing professionals who have expertise in the field of analysis and finance, so that the owners can monitor the development of their investment well. Hence, if the percentage of ownership is large enough (majority), then, they will have an incentive to conduct effective oversight of the management (agent), and have the ability to influence and change the management actions and decisions. In this case, the action can reduce the occurrence of Earnings Management. Therefore, the second hypothesis in this study is:
H 2: the ownership concentration has a negative influence toward earnings management practices.
The larger companies have less desire to do earnings management than the smaller ones because they are seen as more critical by the shareholders and outside parties. Large companies have a larger investor base, so, they have higher pressure to present a credible financial statement. Based on the description, the third hypothesis of this study is
H 3: the Firm size negatively influences earnings management practices.
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Figure 1. Research Framework
The BOC is a mechanism to supervise and provide a guidance and direction to the management of the company; and may reduce earnings management practices by management. Therefore, the fourth hypothesis proposed in this study is:
H 4: The composition of the Board of Commissioners negatively influences earnings management practices.
The Public Accounting Firm (PAF) has a higher incentive to audit more accurately because they have a more specific relationship with the client,and itcould be lost if they provide inaccurate reports. Therefore, the size of the PAF in this study is used as a proxy for audit quality as part of good corporate governance actions in reducing earnings management practices. Thus, the Fifth hypothesis proposed in this study is
H 5: The Public accounting firm size negatively influences earnings management practices.
The Audit Committee is tasked to oversee the financial reports, the external audit, and the internal control system (internal audit) so that it can reduce the Earnings Management practices by means of overseeing the financial report and the external audit oversight. The audit committee improves the integrity and credibility of the financial statements. Therefore, the sixth hypothesis in this study is
H 6: the Audit Committee negatively influences earnings management.
3. Research Method
The population of this study is all the gopublic companies listed in the Indonesian Stock Exchange (BEI) in the range of 2004 to 2008. The Sampling technique used in this study is purposive random sampling method which is in accordance with the criteria proposed by the researcher. The sample taken must meet the following criteria: first, the companieslisted in the JakartaIslamic Index from 2004 to 2008; and Second, the companies issued audited financial statements with the fiscal year ending on December 31 in the range of 2004 to 2008.
3.1 The Operational Definition and Measurement of Variable
In this study, exogenous variables (independent) is the leverage, ownership concentration, company size, and the practice of good corporate governanceproxified by the composition of the Board of Commissioners, the Public Accounting Firm Size and the Audit Committee. Yet, the endogenous variable (dependent) is Earning Management.
Leverage in this study is defined as the number of assets not financed by the shareholders' equity.
Leverage ratio is measured by dividing total debt by total assets of the company.
The ownership concentration is a condition in which the majority of shares are held by certain individual/group, so that they have relative dominant shares if compared to other shareholders. The concentration of stock ownership in this study is measured by the largest percentage shareholding within a company.
The composition of the Board of Commissioners
X4 Ownership Concentration (OC)
X2
The Audit Committee X6
Leverage (LEV) X1
Earning Management
(Y)
Company Size X3
The size of public accounting firm
X5
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The Company size is the size of the company. In this study, the size of the company uses the log value of total sales of the company at the end of the year. The use of the log value of sales is intended to avoid the problem of actual data which is abnormally distributed.
The Composition of the Board of Commissioners (BOC) is the membership consisting of the commissioners from outside the company (independent commissioner) and inside the company. This variable is calculated by dividing the number of independent commissioners to the total number of commissioners.
The existence of the Audit Committee is used to determine whether a company has an audit committee or not. Such information will be checked at each company annual reports and announcements issued by the Indonesian Stock Exchange. This variable is measured by giving a value of 1 (one) if the sample firm has an audit committee, and a value of 0 (zero) if the sample firms do not have an audit committee.
Earnings management is a condition in which the management do intervene in the process of preparing financial statements for external parties so as to flatten, raise, and lower earning reporting. The management can use the leeway of the use of accounting methods, make policies (discretionary) which can accelerate or defer costs and revenues, so that the corporate earning can be lower or higher as expected.
3.2 Methods od Statistical Analysis
To determine the influence of the dependent variable (Y) toward the independent ones (X), it is used multiple regression equation (Ghozali, 2001:7). In this study, there are six independent variables used, so the regression formula in this study is as the following:
Y=bo+b1X1+b2X2+b3X3+b4X4+b5X5+b6X6+ei
4. Findings
In this study, the researcher uses purposive random sampling method. It is a sampling technique that is taken based on the researcher’s criteria. The total sample of this study is 130 companies. This is based on the result of pooling of company data listed in the Jakarta Stock Exchange and the Jakarta Islamic Index (JII) from 2004 to 2008.
Based on the table 1 below with N = 130, it can be obtained the following regression equation: Y = 6.978 + 0.842X1 + 0.114X2 +(-0.589)X3+ 0.523X4 + 0.102X5+ (-0.356)X6 + ei.This regression equation means that if it finds an increase of one unit Leverage (X1) while other variables are constant, it will resultthe increase ofearning management by 0.842. If there is an increase in one unit of Ownership concentration (X2) while other variables are constant, it will resultthe increase ofearning Management by 0.114. If there is one unit that increases company size (X3) while other variables are constant,it will result thedecreaseofearning management by 0.589. If there is an increase of one unit of composition of the Commissioner Board (X4) while other variables are constant, it will resultthe increase of Earning Management by 0.523. If there is an increase of one unit of Public Accounting Firm Size (X5) while other variables are constant, it will result the increase of Earning Management by 0.102. If there is an increase of one unit of Audit Committee (X6) while other variables are constant, it will resultthe decreaseofearning management by 0.356.
Table 1 multiple regresion result
Source: The Calculated Data
T-test is used to determine the influence of each independent variable toward the dependent ones. The dependent variables in this study which are among leverage, ownership concentration, company size, Composition of theCommissioner Board, Public Accounting Firm Size and Audit Committee on earning management are tested to the regression coefficient.
Based on the above SPSScalculation, the significance value of the X1 regression coefficient (Leverage) is 0.008. It can be concluded that there is a significant positive influence of leverage variable toward earning
6.978 1.481 4.713 .000
.842 .315 .225 2.676 .008
.114 .310 .033 .368 .713
-.589 .122 -.436 -4.811 .000
.523 .496 .087 1.053 .295
.102 .141 .066 .724 .470
-.356 .315 -.093 -1.131 .260
(Constant) LEV KS SIZE BOD AUD AUDCOM Model
1
B Std. Error Unstandardized
Coefficients
Beta Standardized
Coefficients
t Sig.
Dependent Variable: AA a.
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management variable. While the X2regression coefficient(Ownership Concentration) results 0.713, thus it can be concluded that it has no significant negative influence of the Ownership Concentration toward Earning Management variable.
The X3regression coefficient (Company Size) results 0.00, so it can be concluded that it has a significant negative influence of the variable size of the Company toward earning management variable. While the X4 regression coefficients (Composition of the Board of Commissioners) is 0.295, so it can be concluded that it has no significant negative influence of the variable of the board of the Commissioner composition toward Earning Management variable. Then, the X5 regression coefficients (Public Accounting Firm Size) results 0.47, thus it can be concluded that there is no significant negative influence of the public accounting firm size variable toward Earning Management. The last, the X6 regression coefficient (Audit Committee) results 0.26. Thus it can be concluded that there is no significant negative influence of the variables of the Audit Committee towardearning Management variable.
5. Discussion
Earning management is an effortdone by the management to raise or decrease earningreported from their responsibility unit. This act is deliberately done for personal gain. Earning management occurs when managers use such policy in financial report and the arrangement of transaction to change financial report, so that it will mislead stakeholders dealing with the economic performance of companies and influence outcomes related to contract that depends on reported accounting numbers. In this study, Earning Management is proven to be influenced by the Income Management Leverage and company size. To reduce the practice of Earning Management, it needs to practice Good Corporate Governance (GCG) by forming audit committee, using Public Accountant Services which are included intothe big four, and increasing the total percentage of Independent Commissioner to the total of Company commissioner. However, this study finds several findings that are not in line with the theory of hypothesis.
Leverage, as a measure of financing activities of the company,has beenproven to have a positive influence on earning management variables. This study is in line with a study done by Achmad et al (2007), Tarjo (2008) which state that there is positive leverage variable to earning management variable. Companies that need additional funds from debt are more motivated to perform earnings management. Due to the increasing amount of debt required by the company, so the managers strive to improve the company's financial performance. If the company's financial performance does not meet the targetsplanned, it can reduce the trust of creditors toward the company. In addition, if the targets are not acquired, it can encourage managers to act opportunistically, for example, they report sales greater than they are. As a result,the reported company earning is too high than it is. This action is intended to convince the creditors to give more funding to the company. So, on the basis of convincing creditors, managers make a fake company earning.
The ownership concentration measured by the percentage ownership of the largest stock of a company is proven to have no significant positive influence. These results are in line with the study done by SuadHusnan (2000) which states that the company of go public with the concentrated stock ownership has a greater risk of the agency problem. Concentration of ownership is still considered as un-well-managed company governance, because it has a majority owner who can directly control the company. In practice, the majority owner becomes manager of the company or at least he has full authority to regulate managers. In accordance with attracting investors, owners can make management as a tool to attract investors by making up the financial report. So that, ownership concentration cannot be used as a mechanism of Good Corporate Governance (GCG) which can inhibit management in performing the earning management activities. Ownership concentration in this study has no significant influence toward earning management. This is because the Ownership Concentration Average of companies that are on the Jakarta Islamic Index (JII) is still less than 50% of the ownerhip of company stock. This means that stock in the Jakarta Islamic Index is still spreading.
Company size which is measured using the total value of company sales is proven to have a significant negative influence on earning management. This is in line with the study done by Siddarta and Veronica (2005) which show that the small companies tend to perform earning management than the large ones. According to the sales volume,common companies which are included in the Jakarta Islamic Index (JII) are categorized into large companies. Indirectly, public pay more attention to large-sized companies than the small ones. In other words, oversight function is applied more to a large company than the small ones. This is becuase the large companies have a greater influence on the economy when compared to the smaller ones. Therefore, the management of large companies will be more cautious and transparent in financial report, so that it will affect the company to have more accurate report.
The composition of the board of Commissioner which is measured by comparing the number of independent directors to total number of Commissioners is proven positive but not significant toward Earning Management. This study is in line with the study done by Nuryaman (2008), which states that there is no significant positive influence of the composition of the Board of Commissioners toward Earnings Management. Most companies listed in the Indonesian Stock Exchange (BEI) and the Jakarta Islamic Index (JII) have lower number of Independent Commissioner Percentage when compared with the percentage of Commissioners from the internalof company. In this study, although the company has found an Independent Commissioner, they should do earning management
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eventhough the value is very low. In this case, the composition of the CommissionerBoard has not proven to be a mechanism of Good Corporate Governance (GCG) which can inhibit management to earnings management.
Theunsignificant influence of composition of the CommissionerBoard in this study is because the measurement of Commissioners CommissionerBoard is not based on the competence of the CommissionerBoard in Accounting field. So, the existence of Independent Commissioner in this study only meets regulation as proposed by Siddharta and Veronica (2005). This studyis supported by Nuryaman (2008) which states that many companies put independent commissioner who less competence in the field of accounting.
The size of Public Accounting firm is measured by the public accounting company of The Big Four, which is shown to have no significant influence toward earning management. In this study, the majority of companies in the Jakarta Islamic Index (JII) which is audited by the public accounting company of the Big Four, however, is proven still practicing earning management eventhoughthe value is low. The study by Siddharta and Veronica (2005) indicates that the size of the firm may not be an appropriate proxy of audit quality. Basically,the audit of the financial statement of a company does not aim to detect whether earning management occurs or not, but the auditing activity is done to enhance the credibility of financial statements. Accounting scandals that occurred in public companies involve reputable public accounting firm, for example,the scandal of PT. Kimia Farma in Indonesia, shows that companies that use the services of reputable public accounting firm have not been able to reduce the amount of earning management. This shows that the size of public accounting firm as a proxy of audit quality cannot be a good corporate governance mechanism that can control the management of earning management activities. This study shows that the size of the Big Four Audit Office is not an appropriate proxy for measuring the quality of audit.
Audit Committee, as a measurement of audit quality, has not significant negative influences toward earning management. In this study, it is proven that the audit committee has no significant influence on earning management. This is because the measurement of the audit committee is only based on the presence or absence of an audit committee. According to the rules of audit committees which are stated in the Directors Letter No.Kep- 305/BEJ/07/2004, it is stated that members of the Committee consists of at least three (3) members; one of whom is the commissioner of the listed company who also serves as chairman of the committee audit, while other members are independent external party where at least one of them has the ability in the field of accounting and finance.
Companies that have an audit committee are not necessarily has complied applicable regulations. Most companies have an audit committee that has not met the applicable regulations, in where one member of the audit committee serves as commissioner of the company. This shows that audit quality as measured by the presence of an audit committee has not been able to provide optimal control to reduce earning management by managers.
6. Conclusion
Based on the findings and discussion explained above, it can be drawn some conclusions as follows: First, Leverage has positive and significant influencetoward earnings management, this finding is in line with the hypothesized theory. Second, Ownership Concentration does not significantly influence earning management, and this finding does not support the theory hypothesized. Third, the size of company has significant negative influence toward earning management. In this case, the larger companies can minimize the occurrence of earning management. Moreover, this finding is in line with the hypothesized theory. Fourth, the composition of the Board ofCommissioneras part of the implementation of Good Corporate Governance (GCG) does not significantly affect earning management, so that, the finding of this study is not in line with the hypothesized theory. Fifth, size of public accounting firm of the Big Four has not significantly affect earning management. So the public of accounting firm of the Big Four cannot be used as one part of the implementation of Good Corporate Governance (GCG). The last, the Audit Committee as part of the implementation of Good Corporate Governance (GCG) in an enterprise significantly influences earning management.
7. Limitations and Suggestions
The researcher uses a small number of samples in this study. This is becuase the research data on the Jakarta Islamic Index (JII) is limited. Further Researchers are suggested to add sample with different periods or other types of industries, so that the expected amount of data with the composition of the boardof the commissioner can be more dominant. Future researchers are also suggested to analyze the characteristics of independent directors to other characteristics of the composition of the board, including the competence of the board of commissioners.
By the research that shows that size of public accounting firm and the Audit Committee has no influence toward Earnings Management,further researchers are advised to use another proxy of audit quality, for example by the proxy of the specialization of public accounting firm.
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