Please describe the difference in earning management between smaller listed firms and large listed firms in Malaysia and also other countries.
In general, I think smaller companies are not under scrutiny by investors and also by regulators. So, I will imagine these smaller companies to have higher earning management. Also, smaller companies are mainly family owned. In order to show that they are doing well in business, I would think that they will be more interested to show high profit to earnings management. So, that was my assumption and motivation to carry out this research.
As emphasized in Malaysian Code on Corporate Governance, what is the role of audit committee in accrual management practices in Malaysia ?
Audit committees are supposed to be well conversant in accounting, accounting standards and latest development in Malaysian Financial Reporting Standards (MFRSs). They must be able to read the financial statements and to be able to scrutinize the accounting principles used by companies. So, the purpose is to make sure that the accounting submission, such as the income statement and balance sheet will present good and fair view of the company’s financial position. These financial statements are not supposed to mislead investors and users, so this is the whole purpose of the audit committee to do the oversight role in the process of preparing the financial statements. Therefore, the requirement is they must be well conversant in accounting.
What are your findings on the discretionary accruals in small listed firms ?
Yes, I found that the incidence of accrual management of small companies is higher. The amount is higher compared to large listed firms in Malaysia. I also found that the accrual in small listed firms is 17 times higher than the average accrual of large companies reported on the main market. So, it means the tendency is higher, higher for smaller firms to manipulate and massage the earnings, so the earnings will be distorted rather than the actual earnings.
In your findings, does board independence influence the propensity for discretionary accruals in these small listed firms?
No, my research didn’t find any significant relationship between independence directors and accrual management in smaller firms. So, what happen is, the board independence does not have any influence on the incidence of accrual management in smaller firms. This is also similar to the findings in larger firms. The possible reason could be the board cannot monitor the whole financial process of the companies, or the job has been dedicated to audit committees. In fact, the requirement of Malaysian Code on Corporate Governance (MCCG) now is the majority of the members of audit committees must be independent. Let’s say if there are 3 members, two of them must be independent. And in between, one member must be financial literate. I think all companies now have already appointed accountants to be inside their audit committees.
Based on your findings, is there any implication that you would like to propose to the policy maker ?
In terms of audit committees and also the board members, they fulfil all the requirements by MCCG. The requirement is for example, they must have three members in audit committees and majority are independent. Besides, one of them must be financial literate. And also, for the board as well, the majority of the board members must be independent. However, it seems that they are not yet able to fulfil their accounting roles, especially for the board as whole. In fact, in my findings, audit committee’s independence is only effective when the incidence of accrual management is high. When accrual management is low, they are not effective. So, they are only able to detect earning management when the earning management becomes severe. Thus, my recommendation is in terms of fulfilling the requirements of MCCG, the focus for the companies should be serious in fulfilling their duties as a member of board. Instead of complying the MCCG, they must achieve the expectation of shareholders, shareholders are expecting them to do their jobs. Their focus should be on the investors and not for the government, not for the CEO and not for the major shareholders of the companies. Their duties are for the shareholders as a whole for the companies to serve the purpose of their existence. They have to remember that all the time.