THE INFLUENCE OF CORPORATE GOVERNANCE TO EARNING QUALITY (Empirical Study: Banking Companies Listed in Indonesia Stock Exchange Period 2008-2012)

RENO, RIZKA FADHILLA (2013) THE INFLUENCE OF CORPORATE GOVERNANCE TO EARNING QUALITY (Empirical Study: Banking Companies Listed in Indonesia Stock Exchange Period 2008-2012). Masters thesis, Universitas Andalas.

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Abstract

Background Financial report is one of the quantitative information that is made by the company. Information about company’s earnings in the financial report is one of indicator that is often used as the basis by interest parties to evaluate the operating and management performance. It is also used to estimate earnings power, and predict future earnings in order to make decision. (Siallagan and Machfoedz, 2006). In the recent years, a wave of corporate scandals has brought financial reporting practices of public companies under considerable. Legislative actions such as the Sarbanes-Oxley (SOX) Act of 2002 have been sought to improve the quality of financial reporting by requiring chief executives to certify what they report, strengthening corporate governance, and improving independent auditor. Whether and to what extent this action has been effective has been the subject of much research recently. Earning quality is an earning with little or no perceived noise and can reflect the company's real financial performance (Chandrarin cited in Widjaja and Maghviroh , 2011). According to Hayn cited in Widjaja and Maghfviroh (2011), perceived noise is an earning that can be caused by transitory events or the application of the concept of accrual accounting. Transitory event is an event that only affects to a certain period, it occurrences is not persistent or continuous and 2 results to the fluctuation of income (loss) reported in the income statement. The greater the perceived noise in earnings, the lower the earning quality. In this research, writer draws on agency theory to develop an empirical framework for examining the link between corporate governance and the financial reporting behaviour of firms. Writer use this framework to formulate and test specific hypothesis on the association between measures of earnings quality and corporate governance. Agency theory provides a natural backdrop for writer’s analysis because financial reporting concern arises when there is a conflict of interests between managers and owners (shareholders) coupled with information asymmetries (Beatty and Harris 1998). In a corporation, the shareholders are the principals and the managers are the agents working on behalf of and for the interests of the principals. Dechow (1995) predicts that this condition can cause problems because of management as a party to provide information about the company's performance is evaluated and rewarded based on the report of its own. A low earnings quality could occur in running the company's business because management is not actually the owner of the company. Manager incentives could be not aligned with those of shareholders’ and stockholder’s incentives. This separation can lead to conflicts between the principals and the agents about the control and management of the company (agency conflict). More generally, the scandals that happened in these recent years have raised a larger issue relating to the nature of the association between corporate governance and earnings quality. According to Shiri et al (2012), corporate governance, in the early twenty-first century after the collapse of big 3 companies like Enron and WorldCom, is one of the most important business issue that is discussed. Policy makers now acknowledged that the issue of corporate governance principles can promote persistence in financial markets, encourage investment and also it leads economic growth. One of the most important tasks of corporate governance also ensured the quality of financial reporting. Furthermore, corporate governance is one factor that can reduce agency costs; therefore, by filtering through limiting opportunistic behavior of management, can lead to improve quality and reliability of reporting and also increases the value of the company (Shiri et al 2012). The purpose of corporate governance in its various forms is to reduce agency problem, suggesting a natural link between corporate governance and financial reporting. All else equal, effective corporate governance should results in high quality of earnings reported. Vafeas (2000) stated that the role of the independent commissioners is expected to improve earnings quality by limiting the level of earnings management through monitoring function of the financial reporting. Siallagan and Machfoedz (2006) found evidence that independent commissioner and audit committee have significant influence to the earning quality. The other research that supported Vafea’s statement is the research by Boediono (2005). In his research, he came to conclusion that independent commissioner and institutional ownership influence earning quality. Klein (2002) provide empirical evidence that companies that established an independent audit committee report have a higher earning quality compare to 4 the firms that did not establish independent audit committee. It is also supported by Suaryana (2005) who found that audit committee influences earning quality. According to Jensen and Meckling (1976) institutional ownership is one of the main corporate governance mechanisms that help to control agency problems. Shiri et al (2012) also stated in his journal that companies which are larger and have more institutional investors, earning quality can be influenced by external governance mechanism. Moreover Fama and Jensen (1983) stated that size of board may influence the quality of earning reported. Although there were plenty researches about the relationship between corporate governance and earning quality, but they still came with different result. Larcker, et al 2007 stated that the relation between corporate governance and earning quality is an issue that has proved elusive and often contentious among accounting researchers. Part of the reason is that the empirical literature that examines earnings quality and corporate governance has found weak and inconsistent results. It also becomes one of reason that makes writer interested to do this research. The title of this research is The Influence of Good Corporate Governance to Earning Quality (Empirical Study: Bank Companies listed in Indonesia Stock Exchange IDX Periodic 2008-2012. In this research writer use banking companies as the research sample and this is different with other previous research which used manufacturing companies as their research sample. The reason of writer to use banking company listed in Bursa Efek Indonesia as the sample for this research is because in Indonesia most of Banks are include in LQ5 45 and tend to have had good corporate governance. As Akhtar (2008) stated that Good corporate governance for banks is critical because: 1. It need to ensure solvency and stability of the financial system as effectively governed banks are more efficient and prudent in directing their resources, 2. It need to ensure aligning the interests of the management with equity and debt holders, 3. The ownership and group structure of banks is varied. In such a scenario, transparency and fairness in banks’ lending and investment decisions, particularly those concerning group companies, becomes a crucial requirement, 4. In order to build public confidence in credibility of their operations. Banks operate in a highly vulnerable environment where bonafide or perceived impression of malpractices in a bank’s dealings could trigger a run on its deposits.

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