Corporate Governance And Earnings Management Accounting Essay

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This chapter gives an overview regarding to this research generally. It consists of research background, problem statement, research objectives, and the contribution of study. Basically, this chapter outlines the basic ideas regarding to this research.

Background

Evolution of Corporate governance in Malaysia

As defined in the Malaysian Code on Corporate Governance 2012(MCCG 2012), corporate governance is the process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long-term shareholder value, whilst taking into account the interests of other stakeholders. After the Asian Financial Crisis 1997/98, the economies of Thailand, Indonesia, South Korea, Philippines, Singapore and Malaysia have been severely affected and lower down the investor confidence towards those countries. The economic crisis has exposed Malaysia to various serious weaknesses in corporate governance practices namely, weak financial structure, over-leveraging by companies, lack of transparency, disclosure and accountability (Rashidah and Fairuzana, 2006). Business community began questioning the effectiveness of corporate governance mechanisms within an organization (Norman, Takiah, and Mohid, 2005) in Malaysia. Hence, the first version of Malaysian Code of Corporate Governance was drafted in 1999 and approved in March 2000 by the Ministry of Finance in order to to improve the monitoring function of corporate governance mechanism in Malaysia. The Code codified the principles and best practices of good governance and described optimal corporate governance structures as well as internal processes (MCCG 2007). It aimed to rectify and strengthen legal and regulatory frameworks in the companies. Since then, MCCG 2000 had been developed and replaced by MCCG 2007 by Securities Commission (SC). MCCG 2007 represented the continued collaborative efforts between Government and the industries to further strengthen the board of directors and audit committees, and ensuring that the board of directors and audit committees discharge their roles and responsibilities effectively (MCCG 2007). In the next decade, SC would focus on enhancing the corporate governance ecosystem. Thus, SC issued the Corporate Governance Blueprint 2011(Blueprint) which figures out the strategic plan aimed to reinforcing self and market discipline, which MCCG 2012 is the key deliverable of the Blueprint. The development was due to changing in market dynamics, international developments and the need to continuously recalibrate and enhance the effectiveness of the corporate governance framework.

Based on The Star news report dated 3 July 2012, Bursa Malaysia will continue to have a significant focus on corporate governance and disclosure to further build up the market. The CEO of Bursa Malaysia, Datuk Tajuddin Atan said in the press that he wants the listed companies to appreciate the greater value that comes in underscoring corporate governance practices into the core of business operations as that will create good business sustainability. He added that the corporate governance is a shared responsibility and it is not the sole preserve of the regulators but the obligation of all participants to exercise greater care and responsibility in promoting value creation and sustainability through mutually-reinforcing efforts.

We could say that corporate governance issue has become one of the hot topics in the business and attracted attention among the professional, academics, and officials involved in the economy. The management level has gained higher awareness on the value of having good corporate governance regardless small, medium or listed company. Good corporate governance mechanism takes care of shareholders' welfare and also provides the linkage between the stakeholders the company in order to sustain the business for longer time. Generally, good corporate governance has to fulfill 7 characteristics as listed below, namely discipline, transparency, independence, accountability, responsibility, fairness, and social responsibility(second King report on Corporate Governance, 2002). According to Asian Corporate Governance Association-CLSA Watch Report 2012, Malaysia was ranked jointly with Japan in the fourth position, after Singapore, Hong Kong and Thailand. The Asian Corporate Governance Association (ACGA) is an independent, non-profit membership organization dedicated to working with investors, companies and regulators in the implementation of effective corporate governance practices throughout Asia. Malaysia's scores for the corporate governance macro category have improved in 4 out of 5 areas while the overall score rose 3 percentage points to 55% in 2012 from 52% in 2010. It shows that the companies in Malaysia seem to be taking more interest in improving corporate governance practice (The Star Online, 28 September 2012).

Hence, we knew that corporate governance has attracted considerable attention from regulators, academicians, and practitioners due to the widely held belief that corporate governance enhances investor goodwill and confidence and boosts the economic health of listed companies (Coleman and Biekpe, 2006; Garg, 2007). Therefore, a company must show high level of accountability and sustainability in order to create a good reputation. In this case, the management is possibly motivated to manipulate earnings due to maximizing firm's value (Beneish, 2001), avoid negative earnings surprises (Matsumoto, 2002), and avoiding reporting losses and earnings declines (Park and Shin, 2004). In Malaysia, every listed company is required to submit audited financial statement and annual report within the time frame set by Bursa Malaysia (formerly known as Kuala Lumpur stock Exchange). As financial statements provide value-relevant information to the external parties of the organization, the heavy reliance placed on accounting numbers create powerful incentives for managers to manipulate earnings to their own advantage. The incentives for managers to manipulate reported earnings may be influenced by job security, contractual agreements between managers and the external stakeholders, self interest in the presence of compensation schemes or the need to achieve target earnings and to meet market expectation (Healy and Wahlen,1999). As such, earnings management, even it is being done not in violation of the accounting standards, may lead to inaccurate information about the company. Hence, the researchers say that it is crucial for an organization to have an effective corporate governance mechanism to safeguard the rights of the investors in getting the true and fair information of the company (Rashidah and Fairuzana, 2006). Incentive to engage in earnings management could be mitigated as well through effective corporate governance mechanism (Fatimah, Hasimah, Sharifah, and Raida, 2009).

In this study, I will focus on audit committee characteristics and examine how the characteristics mitigate the level of earnings management in the company. According to Healy and Wahlen (1999), earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. Various researches have been done on audit committee's characteristics in Malaysia. The trend shows that audit committees play a significant role in oversee reporting and internal control, as well as improving the relevance and reliability of an entity's financial reporting nowadays.

Problem Statement

Malaysia public listed companies have been required by Bursa Malaysia to establish an audit committee since 1 August 1994 (Rashidah and Fairuzana, 2006). A board of a listed company should establish an audit committee comprising at least three members, the majority of whom are independent, while all members should be non-executive directors. The effectiveness of board can be increased by appointing committees with specialized skills (Audit committee and corporate governance, Deloitte 2009). Audit committee is one of the important aspects in corporate governance stated in the Code (Norman, Takiah and Mohid, 2007). Hence, it is crucial to investigate the audit committee characteristics and how it affects the level of earnings management. This question is to be examined in the context of Malaysia public listed companies with respect to the impact the Malaysian Code on Corporate governance on the companies as well as the extent of earnings management.

Research Questions

The research questions in this study are:

Is there any impact of corporate governance mechanism on the earnings management?

Is there any relationship between size of audit and earnings management?

Is there any relationship between the independence of audit committee with earnings management?

Is there any relationship between frequency of audit committee meetings and earnings management?

Is there any relationship between the competence of audit committee and earnings management?

Research Objectives

The research objectives in this study are:

To examine the relationship between size of audit committee, independence of audit committee, frequency of audit committee meetings, competence of audit committee with earnings management.

To test whether enhancing corporate governance mechanisms is associated with the earnings management in the public listed companies.

To examine whether the implementation Malaysian Code of Corporate Governance impacts firm's level of earnings management.

To assess the effectiveness of audit committee to monitor management behavior in mitigating earnings management practice within Malaysia's regulatory and business environments.

Contribution of research

The study contributes to the understanding and knowledge on the effect of effective audit characteristics in mitigating earnings management practice in a developing country such as Malaysia. Besides the study also provide the understanding of Malaysia Code of Corporate Governance regarding earnings management towards Malaysian regulators, since MCCG 2012 was newly issued.

In Malaysia, there are quite a number of researches done on the relationships between board characteristics, ownerships, independent directors and earnings management but limited researches have been conducted on audit committee characteristics. Hence, I believe that it will provide a deeper look on the Malaysia's listed companies' performance on corporate governance and their practices of earnings management.

Summary

The remainder of the proposal is organized in three sections as follows. Next chapter will discuss and review the relevant literature on issues regarding the audit committee characteristics and earnings management, followed by the development of hypothesis for the research topic. The third chapter will explain the research methodology used to perform the analysis of independent variables and dependent variable, as well as the sample size chosen. The final chapter will conclude the proposal.

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