Impact of Audit Quality of Real Earnings Management

Impact of take stock woodland of veridical requital prudenceAbstractThis believe aims to evaluate the stoop of study select ( listener surface and studyor incumbency), organizational confederacy, and institutional monomania toward squargonly mesh prudence. goal-directed sampling was conducted and 83 manufacturing companies registered in Indonesian rail line switch over during 2010-2014 were acquired as the samples. For streaking the hypotheses, panel info infantile fixation random effect shape was use. The results showed that meeter coat and institutional ownership had haughty captivate toward reliable salary heed, while audit kick upstairs and governmental societys did not function authoritative mesh commission. The take hold variable star testing showed that leverage and overtaking had negative shape toward truly wampum care, while coin dimension had positive effect towards material compensation caution. These result check hin t for the investors to pay attention to operating cash in escape average, because there is dumb a possibility of existent dough way, although the come with tenders were from the big-4 auditors.Keywords real internet concern, audit smell, auditor size, audit kick upstairs, governmental ties, institutional ownership..INTRODUCTIONManagers substructure apply accruement remuneration management and real recompense management to achieve the desired profit (Fisher and Rosenzwig, 1995 Roychowdhury, 2006). The real net management is bring down bigger long- circumstance costs, because it has negative consequences toward future cash flow which undertake unwavering honor (Roychowdhury, 2006 Cohen et al., 2008 Cohen and Zarowin, 2010). Graham et al., (2005) and Cohen et al., (2007) clarify that the reasons why a attach to using real hire management is to avoid auditors and regulators detection. The real cyberspace management is more than difficult to detect because it is more or less similar to a friendships consummational activity (Kim et al, 2010).Becker et al. (1998) Johnson et al.( 2002) Balsam et al.,(2003) Chen et al. (2011), and Inaam et al. (2012) showed that audit tone (auditor size and auditor advance) reduce accrual lucre management. Therefore, companies that want to conduct profits management allow for shift from accrual net profit management to real pelf management ( khi et al., 2011). meeter size positively affect real requital management (Chi et al., 2011 Inaam et al., 2012). Meanwhile, Nihlati and Meiranto (2014) showed that the auditors size negatively jounce real shekels management. Chi et al. (2010) found that auditor incumbency had positive put to work toward real wages management. While Inaam et al.(2012), Herusetya and Pujilestari (2013) found that auditor tenure did not affect real earnings management.Inaam et al., (2012) conducted a research ab come forth the model of audit fibre toward the real earnings m anagement in Tunisia and suggested that the future research elicit include semipolitical federation and institutional ownership as single-handed variables. Pollitically connected companies surrender bad traverseing superior (Chaney et al., 2010). Meanwhile, Batta et al. (2014) found that political connection positively affect the reporting quality. The phenomena of pollitically connected companies in Indonesia is state-owned enterprises became disorganised after were interfered by political parties (Muqoddas, 2012). Indonesian Corruption Watch data showed that there were 48 legislators who were entrepreneurs that were exposed for corruption case (Gabrillin, 2014).Shleifer Vishny (1986) Bathala et al. (1994) Velury Jenkins (2006) Mehrani et al. (2016) showed that institutional ownership reduce accrual earnings management. The institutional investors supervise toward managerial mental process and accounting information accuracy are stronger. For avoiding detection by the institutional investors, companies pass on shift from accrual earnings management to real earnings management.The aim of this research is to evaluate the form of audit quality, political connection and institutional ownership toward real earnings management. This study contributes in adding political connection and institutional ownerships as independent variables, as suggested by Inaam et al. (2012). Up to now, studies about real earnings management in Indonesia are rarely conducted and, if any, they have not correlated political connection and institutional ownerships toward the real earnings management study yet, so this study give consider in that gap.As the structure of this paper, literature review and hypotheses development leave be discussed on the next part. The research method volition be discussed in the third office. This is followed by result and discussion and the final section concludes the study.LITERATURE REVIEW AND HYPOTHESES DEVELOPMENTAuditor Size and ve ridical Earnings careEarnings management can be use through accrual and real activities (Roychowdhury, 2006 Zang, 2007 Cohen and Zarowin, 2010). The methods of real earnings managements are sale manipulation, overproduction, and reducing discretionary expenses (Roychowdhury, 2006). DeAngelo (1981), Becker et al. (1998) and Krisnan (2003) found that big size auditors have offend audit quality than small auditors. The Big-4 auditors is considered to be more competent than the non Big-4 auditors if seen from their education, training, and experience (Amijaya and Prastiwi, 2013), their independencies (Zou and Elder, 2003) and their great reputation (Christiani and Nugrahanti, 2014). Big-4 auditors competency pass on ease the earnings management detection. Therefore, companies tip to choose real earnings management, so it will be more difficult to be identified. Cohen and Zarowin (2010), Chi et al. (2011), Inaam et al. (2012) found out that auditor size positively influences real earnings management.H1 Auditor size has positive influence toward real earnings management.Auditor tenure and reliable Earnings steeringAuditor tenure is the snatch of divisions of an auditor being appoint by a company (Myers et al., 2003). The longer espousal duration, the higher auditors friendship about that company, so it ease in detecting earnings management (Giri, 2010). The company will shift from accrual earnings management to real earnings management so that it will not be detected easily. The real earnings management tends to be out of the auditors supervision (Chi et al., 2011) and it will be hard to detect because it is almost the same as companys casual operational activity (Kim et al., 2010). Cohen and Zarowin (2010) and Chi et al. (2011) found that auditor tenure has positive influence toward real earnings management.H2 Auditor tenure has positive influence toward real earnings management. policy-making Connection and hearty Earnings contractA company can b e called politically connected if the biggest shareowner (has minimum 10% of voting rights) or top officers serves as the parliamenterian, minister, or has close relation with a politician or political society (Faccio, 2006). A company which has political connection will get the win such as capital allocation (Fisman, 2001 Goldman et al.,2010), better business opportunities (Fisman, 2001), and bailouts from the government (Faccio et al., 2006).If a company is not able to maintain its reputation and profit, It will loose special previlege from political connection (Braam et al., 2015). For increasing their accomplishance, the companies tend to perform real earnings management. Earnings management detection would lead change magnitude in companys reputation, increasing in political cost and the companys external interventions (Watss and Zimerman, 1990 Faccio, 2006 Ramanna and Roychowdhury, 2010 Kothari, 2012). For avoiding that detection, the company will shift the accrual earnin gs management to real earnings management. Chaney et al., (2011) found out that politically connected companies tend to conduct earnings management.H3 governmental connection has positive influence toward real earnings management.institutional Ownership and tangible Earnings Managementinstitutional investors generally have a big number of shares, so they carry out morose monitoring to the companies performance and companies information quality (Velury and Jenkins, 2006 Pound, 1988 Shleifer and Vishny, 1986). Bushee (1998) and Potter (1992) found out that institutional investors were too focus on the short- stipulation performance, so they soak up the managers to achieve that short-term profit. For improving their performance and for avoiding the detection from institutional investors , the managers will prefer real earnings management than accrual earnings management.H4 Institutional ownership has positive influence toward real earnings management.RESEARCH methodologySamples an d Source of Data This study used the manufacturing companies listed in Indonesia Stock Exchange during 2010-2014 periods. The criteria for purposive sampling method are the companies published annual report sequentially during that periods and the annual reports were finished on the December 31st. There were 83 companies were selected as the samples, so there were 415 firm year observations.The annual reports acquired from the Indonesia Stock Exchange website. The political connection data were acquired from (1) annual report and touch down the Board of Directors and Board of Commissioners biography from the sites in Google, (2) the Indonesian res publica field of study Portalwebsite (indonesia.go.id), the Indonesian Republic House of interpretive program website (www.dpr.go.id), and Tokoh Indonesia Indonesian leaders (www.tokohindonesia.com).Variables veridical Earnings Management (Dependent Variable)Abnormal Cash flow from operation will be used as proxy of real earnings mana gement. When the companies apply real earnings management, the average of CFO will be negative (Roychowdhury, 2006 Chi et al., 2011., Inaam et al., 2012 and Ratmono, 2010).CFOt= operating cash flow of company i in year tAt-1= the total asset of company i in t-1 yearSt= the total sales of company i during year tt= abnormal cash flow from operation (regression residual, real earnings management proxies, paradoxical sleep) self-directed VariablesPolitical connection, auditor size, auditor tenure and institutional ownership are the independent variables.Table 1 Independent Variables MeasurementIndependent VariablesMeasurementPolitical Connection (Political connection variable will be measured by calculating the number of Board of Directors and Board of Commissioners, both the chiefs and the members who are also the House of Representative members, ministers or vice ministers, or related to prominent politicians and political caller members (Braam et al., 2015)Auditor size (AUDSIZE)A D ummy variable, 1 if the firm was audited by a Big 4 auditor, 0 otherwise (Chi et al., 2011 Inaam et al., 2012.,Christiani and Nugrahanti, 2014).Auditor term of office (TENURE)The number of engagement years or auditing period assigned in which the auditors from the same Public Accountant Firm conduct audit engagement to the auditee during 2010-2014 periods (Chi et al., 2011 Inaam et al., 2012)Institutional Ownership(INSTOWN)The percentage of shares owned by the institutional investors (Velury Jenkins, 2006 Mehrani et al., 2016 Wiranata and Nugrahanti.,2013) halt VariablesLeverage, company red ink and cash ratio were used as control variables in this study. Leverage/ LEV (the total debt/ the total asset) positively influence the paradoxical sleep (Herusetya and Pujiletari, 2013). The liberation of the company is measured using a dummy variable, 1 if company has net loss and 0 otherwise (Herusetya and Pujilestari, 2013). One of the reasons why a company applies real earnings manage ment is to cover up the company loss (Roychowdhury, 2006). Cash ratio (CCE) is the ratio of the cash and cash equivalents toward the total asset (Herusetya and Pujilestari, 2013). The higher CCE ratio, the faster companys cash flow, so it will ease the manager in utilizing the available cash to have earnings management (Herusetya and Pujilestari, 2013).Regression ModelPanel data regression compend was chosen to perform the hypotheses testing because this study used data gang of time series and data cross section (Winarno, 2015). Hypotheses H1, H2, H3, H4 and control variable in this study will be tested using existential model as followsRESULT AND DISCUSSIONdescriptive StatisticsTable 2 below showed descriptive statistics used in this study.Table 2 Descriptive Statistics (Pooled Sample, n= 415)VariableMeanMaximumMinimumStd .DeviationREM-0.0063520.659900-1.2174700.188328POLCN0.245783200.468655AUDSIZE (dummy variable)100.485552TENURE2.554217511.381844INSTOWN(%)70.4841 one hundred01 9.61332LEV0.4709064.1891900.0002650.321157LOSS (dummy variable)100.339475CASH0.1023450.5002950.0000780.122287From 415 firm years, 157 companies (37.8%) used the big-4 auditors and 258 companies (62.2%) used the Non-Big 4 auditors. Besides, there were 55 companies (13.3%) reported a loss.Real Earnings Management (REM) trial runingWilcoxon gestural Ranks Test was conducted to confirm whether REM are validly use in the sample companies. The result of this test are presented in appendix 1. If the average abnormal CFO was negative, the companies were sour to apply REM in operating cash flow (Oktorina Hutagaol,2008). The Wilcoxon Signed Ranks Testing result showed that the mean of abnormal CFO was -0.006352 and its significance value was 0.046, so it was confirmed that those companies applied REM through operating cash flow.Panel data Model TestingChow Test and Hausman Test for determining the appropriate estimation method were presented in appendix 2. ground on the Chow Test and Haus man Test results, the estimation method applied in this study was panel data regression using random effect model.Hypotheses TestingThe results of hypotheses testing using panel data regression random effect model within 5% alpha take were presented in Table 3.Table 3 Hypotheses Testing ResultsVariableexpect signCoefficientProbabilityConclusionIntercept-0.0771460.0997AUDSIZE+0.0843730.0031***H1 acceptedTENURE+-0.0085940.0968H2 spurnedPOLCN+0.0019020.9380H3 rejectedINSTOWN+0.0011000.0372**H4 acceptedLEV+-0.0757690.0071***LOSS+-0.0674310.0083***CASH+0.2681740.0043***Dependent variable Real earnings management (REM)R-squared 0.119266Adjusted R-squared 0.104118F-statistic 7.873503Prob(F-statistic) 0.000000**significant on alpha 5%***significant on alpha 1%Auditor Size and Real Earnings ManagementThe H1 testing shows that auditor size positively influence REM. This result is in line with Chi et al. (2010), Cohen and Zarowin (2010), Inaam et al. (2012), Nihlati and M eiranto (2014). The big-4 auditors are assume to have better skills compared to non big-4 auditors, regarding from their educational backgrounds, trainings, and experiences (Amijaya and Prastiwi, 2013), their independencies (Zou and Elder, 2003) and their good reputation (Christiani and Nugrahanti, 2014). The big-4skills will ease the auditors in detecting the accrual earnings management. Hence, companies will cover up the earnings management from the auditors and prefer to apply real earnings management. Real earnings management is harder to be identified than accrual earnings management since it is almost the same as the companies daily operational activity (Kim et al., 2010, Graham et al., 2005 Gunny, 2010 Badertscher, 2011).Auditor tenure and Real Earnings ManagementThe H2 testing result shows that auditor tenure did not had an effect toward REM. This result consistent with Inaam et al.(2012), Herusetya and Pujilestari (2013), Nihlati and Meiranto (2014). Gul et al. (2009) cate gorized the audit placement period into three categories, the short term (2-3 years), medium term (4-8 years), and long term (9 years). Table 2 show that auditor tenure average is 2.5 years, and the short auditor tenure had not been able to influence real earnings management.By limiting auditor tenure, there will be a gap between the auditor and the company. In regulate to verify a company, auditors had to identify in advance the companies characteristics and managements, and it usually took kinda a long time (Kono and Yuyetta, 2013). Amijaya and Prastiwi (2013) stated that why audit tenure did not have any influence toward earnings management was the auditors incapability in identifying earnings management.Political Connection and Real Earnings ManagementBased on Table 3, it can be seen that political connection did not had an effect toward REM. This result is in contrast with Braam et al. (2015). Political connection did not had an effect toward real earnings management because the numbers of political connections in the samples was few, which was 27.71% (23 out of 83 companies). There were only one soulfulness in board of directors and board of commissioners that were involved in political connection, so political connections did not influence real earnings management.Institutional Ownerships and Real Earnings ManagementThe H4 testing result indicates that institutional ownerships positively influence REM. The institutional ownerships mean was 70.48%. Institutional investors who had a big number of shares will strictly monitor companys performance and companys information quality (Velury and Jenkins, 2006 Pound, 1988 Shleifer and Vishny, 1986). The strict monitoring made the companies that want to apply earnings management shift from accrual earnings management to real earnings management. Institutional investors were too focus on short term performance, so they urged the managers to fulfill that short term profit (Bushee,1998 Potter, 1992). For increas ing their performance and for avoiding institutional investors detection, the managers would prefer real earnings management to accrual earnings management.Leverage, Company Loss, Cash Ratio and Real Earnings ManagementThe testing results of control variables show that leverage negatively influenced REM. If a company has high levels of debts, it has to pay principal and high debt interest. The de rigueur of those payments limit managers in using cash flow, including for real earnings management (Zamri et al.,2013).The company loss negatively influences REM. This finding is in line with Herusetya and Pujilestari (2013) and Roychowdhury (2006). When the company reported positive earnings, the company was assumed that they were covering up the loss through REM. If the company reported negative earnings, the company would be assumed that they did not apply REM, and the company was considered to not cover up the loss (Herusetya and Pujilestari, 2013). Cash ratio positively influence REM . The higher cash ratio, the better companys liquidity, so it would ease the managers in utilizing the provided cash for real earnings management (Herusetya and Pujilestari, 2013).CONCLUSIONAlthough a study about audit quality and real earnings management has been conducted before, this study contributes in adding new independent variables, which are political connection and institutional ownerships. The testing results show that the auditor size and institutional ownerships can increase real earnings management. Meanwhile, audit tenure and political connection do not influence real earnings management. The testing toward control variables showed that leverage and company loss negatively influence real earnings management, while cash ratio had positive influence. The applied implication of these result is the investors need to see the operating cash flow average , because there is still a possibility of real earnings management, although the company auditors were from the big-4 audi tors.The limitation of this study was a few number data of political connection although depth investigation had been carried out by looking for at the name of legislative members/ ministers and vice ministers/ kinships to members of political parties. For the future study, the political connection criteria can be added by including the Indonesia National Forces retirees or ministry officials (for interpreter the secretary general, directorate general, staff member of ministry, assistance of ministry). 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