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GOVERNANCE MECHANISMS ON EARNINGS MANAGEMENT OF INDUSTRIAL COMPANIES

FACTORS INFLUENCING CORPORATE GOVERNANCE MECHANISMS ON EARNINGS MANAGEMENT OF INDUSTRIAL COMPANIES LISTED IN AMMAN STOCK EXCHANGE AND BURSA MALAYSIA

CHAPTER 1

INTRODUCTION

1.1       Introduction

 

Recently, several scandals were reported due to earning management. These example belong to the first decade of the millennium and includes the Enron Corporation which engaged in extensive earning management to inflate its reported profits and hide debts in 2001 (Gallop & Lewis, 2022).  Similarly, in 2002, the WorldCom improperly accounted for expense lead to inflated profit (Petra & Spieler, 2020). The examples go on in 2009 where Indian company named Satyam when its founder admitted to inflating the company’s financial figures (Gurung & Gupta, 2019).  In Japan, Toshiba in 2015 admitted overstating its profits (Demetriades & Owusu-Agyei, 2022) and Tesco in UK also admitted to overstating its profits (Mohapatra & Kumar, 2021). In US again, the Sears Holding Corporation faced allegation of enrings manipulation and improper recognition of revenues (Hove et al., 2019). Luckin Coffee in China was involved in a scandal in 2020 when it disclosed that it had fabricated sales and expenses. All these examples the main purpose of the companies to attract more customers and enhance the price of the stock of their companies in the market.

 

Earning management is one of the big issue that faces companies and investors as well as the economy of countries. It is defined as a deliberate action taken by management by changing financial reports to mislead stakeholders (Nanda et al., 2022). Earnings management can be done using several methods such as revenue smoothing which refer to the practice of distributing revenue or costs over many time periods in order to present a consistent and stable financial performance for a corporation (Sadatrasoul et al., 2023). Another method is the big bath which refers to the practice companies deliberately declare significant losses during a certain time in order to establish a “reserve” that may be used to offset future gains (Hensel & Schöndube, 2022). This strategy is employed to make future earnings look stronger and more impressive. Additionally, companies can also use aggressive revenue recognition by recognizing revenue before it is really earned or using dubious procedures (Okaily et al., 2019). Further, postponing or postponing valid costs might artificially increase profits (Sayal & Singh, 2020).

 

Researchers suggested that there are several reasons for companies to practice earning management. Companies may engage in earnings manipulation to align their financial results with or above analysts’ earnings estimates, hence potentially increasing their stock prices (Gonçalves et al., 2021; Zalata et al., 2022). Further, earning management is practiced by companies to prevent violations of debt covenants linked to financial measures (Buchholz et al., 2020). Executives can also practice the earning management to get financial incentives that are linked to the success of the firm, leading to the manipulation of results (Saona et al., 2020). These practices have severe impact on stakeholders, and these include investors, creditors, regulators, and employees as well as the economy at large due to the market volatility and diminishment of investors’ confidence and trust in the economy (Kontesa et al., 2021).

 

As a consequence, regulators always aim to enforce a transparent reporting of financial results (Costello et al., 2019). Corporate governance is defined by OECD as “a set of relationships between a company’s management, its board, its shareholders and other stakeholders” (OECD, 2019). The interest in governance can be traced back to the last century. The financial scandal case of Cadbury in 1992  is one of the early reports on governance involving listed companies in the United Kingdom (UK), which resulted in a lack of investors’ confidence in the financial reporting quality. The report aimed to address the financial aspects of corporate governance and suggested that the board of directors (BOD) and audit committee (AC) must play a significant role in monitoring the financial reporting of companies (Price et al., 2018). After several corporate and accounting scandals, policy makers in the United States (US) enacted the Sarbanes-Oxley Act (2002). The act was to improve information disclosure and financial reporting transparency (Chu & Hsu 2018). It aimed at addressing the governance issue and protecting the investors from fraudulent financial reporting by the corporation (James & Lirely, 2021).

 

Countries and organizations have attempted to develop a code of corporate governance (CCG) for effective governance implementation. OECD created the first comprehensive CCG in 2004. Since then, most member and non-member of OECD has taken it as a source to develop their national code of governance (Sawalqa 2014). The code reflects the country’s economic, regulatory, and policy and is specific for each country. However, corporate governance in the Middle East is highly affected by the ownership structure. The existence of royal family members and the concentration of ownership by families or public and governmental bodies are making the governance less effective (Dinh & Calabro, 2019; Nasser, 2019).

 

Jordan is a monarchy where stated owned and family-owned companies are listed in the stock exchange. In 2007, Jordan’s Securities and Exchange Commission established a Code of Corporate Governance Practices to emphasize the necessity of corporate governance implementation by Jordanian businesses (Abu Siam et al., 2018). The country has requested companies to adhere to CCG in 2009. Separate CCG was created for banking industry which has to fulfill certain level of reporting. Differently, a code for non-banking companies is also enforced (Kimani, 2014).

 

In Jordan, as well as in other nations, earnings management may occur in several forms and may include the manipulation of financial accounts to accomplish certain goals. Jordan has a regulatory framework that encompasses the Jordanian Companies Law, which establishes regulations and criteria for corporate governance and financial reporting (Amayreh, 2021). The Jordan Securities Commission (JSC) is the governing authority responsible for supervising the capital markets, and it has a vital function in ensuring compliance with financial and transparency regulations (Al-Msiedeen, 2019). Jordan has implemented International Financial Reporting Standards (IFRS) for the creation of financial statements by publicly listed enterprises (Haddad et al., 2017). The use of international accounting standards seeks to improve transparency and comparability.

 

Effective company governance policies are crucial for countering profit manipulation. The Jordanian corporate governance system promotes the formation of audit committees, inclusion of independent directors, and implementation of governance norms for publicly traded firms (Alabdullah & Naseer, 2023). Jordan, similar to other developing economies, has obstacles with earnings management, including limited knowledge, difficulties in enforcement, and insufficient regulatory supervision (Al-Haddad & Whittington, 2019). The JSC and other regulatory authorities in Jordan are making efforts to improve financial reporting and transparency processes. They have endeavored to enhance corporate governance standards and enhance enforcement tools (Alodat et al., 2022).

 

External auditors have a vital function in scrutinizing financial statements and evaluating the integrity of financial reporting (Salih & Flayyih, 2020). Competently qualified and autonomous auditors may assist in identifying and averting earnings manipulation (Alzeban, 2020). External auditors play a critical role in avoiding earnings management in Jordan, as they are responsible for independently examining a company’s financial statements to ensure accuracy, transparency, and compliance with accounting standards (Al-ahdal & Hashim, 2022). Their role is essential in maintaining the integrity of financial reporting and deterring practices of earnings manipulation (Manita et al., 2020).

 

Due to the similarity of CCG in regional countries and the large gaps between developed and developing countries (Almaqtari et al., 2021; Farah et al., 2021), the study aims to compare the practices of corporate governance and earning management in Jordan with those in Malaysia. Malaysia is an emerging economies that have established a good corporate governance and enhanced the level of compliance with governance. The establishment of CCG in Malaysia can be traced back to 2000 (Singam, 2003). In 2000, Malaysian Securities Commission established the “Malaysian CCG” (Singam, 2003). This event represented a notable advancement in the promotion of effective corporate governance standards in Malaysia, as well as the improvement of transparency, accountability, and the safeguarding of shareholders’ rights (Hua & Zin, 2007). The Malaysian CCG has been revised and updated periodically to conform to worldwide best practices and increasing standards of corporate governance (Khatib et al., 2022; Shamsudin et al., 2018). The purpose of these changes is to enhance the governance structure for Malaysian public-listed firms and bolster investor trust in the country’s capital markets (Ahmed Haji & Mubaraq, 2015; Khatib et al., 2022). The next section discusses the background of this study.

 

1.2       Background of Study

 

The topic of earnings management is of great importance due to its potential impact on stakeholders and the overall economy. The financial crisis of 2008-2009 exemplifies the detrimental impact of inaccurate financial information, worsened by questionable accounting and earnings management practices, which resulted in significant economic downturns on a global scale, extending beyond the United States (Vukovic, 2021; Weißschnur & Weißschnur, 2021). The financial crisis that occurred in 2008-2009, commonly known as the Global Financial Crisis (GFC), was a significant economic downturn comparable to the Great Depression of the 1930s. The origins of this can be traced back to the U.S. housing market and the practices of financial institutions (Quillian et al., 2020). During the period leading up to the subprime mortgage crisis, there was a significant prevalence of earnings management in the financial industry (Eng et al., 2019). An important factor contributing to the situation was the subprime mortgage crisis. Several financial institutions, such as Lehman Brothers, participated in dubious lending practices by providing subprime mortgages to borrowers with poor credit histories (Agarwal & Varshneya, 2022).

 

Financial institutions bundled risky mortgages into complex financial products, including mortgage-backed securities and collateralized debt obligations (CDOs), in order to make profit (Quillian et al., 2020). The products were subsequently sold to investors, who were enticed by the prospect of substantial returns. The value of mortgage-related assets was overstated through the use of accounting techniques, resulting in inflated reported earnings (Prechel, 2020). These financial institutions disseminated inaccurate information to investors regarding the quality and risks associated with their assets and investments (Agarwal & Varshneya, 2022). Investors were drawn to this misrepresentation, as they believed it to be a reliable basis for their financial choices (Agarwal & Varshneya, 2022).

 

Due to the crisis, most countries around the world has started to implement the code of corporate governance. In Jordan, the code was effective after January 2009. However, prior to this date several laws were existed such as the company law. In Malaysia, the code was initially developed in 2000. Nevertheless, several crisis and scandals that involve earning management were occurred in both countries. Jordan has had a number of financial meltdowns, including Petra Bank in 1989 and Shamayleh Gate in 2002 (Alhmood et al., 2020). The Shamyaleh Gate incident, in particular, cost Jordanian banks more than $1 billion, drawing attention to corporate governance (Alhmood et al., 2020). Jordan had a severe financial crisis as a result of this event, which resulted in business failures and a drop in the Jordanian Dinar (JD) exchange rate from USD 3.35 in 2006 to USD 1.41 in June 2008 (Irshoud, 2022).

 

Tax consultant Basil Abu Sultana said that the percentage of companies and institutions in Jordans that employ accounting programs in their work reaches 75% of institutions and companies, regardless of their economic activities. These companies uses these software to manipulate the accountings figures. The head of the Auditors Association in Jordan, Imran Al-Talawi, confirmed that companies uses earning management for several reasons such as for tax evasion or to  present a positive and appealing accounting figures for attracting investors. This manipulation cannot be done without the assistance of the accounting department in the organization.

 

A famous example of earning management is the Petra Bank. Petra Bank, a large Jordanian financial institution, encountered a substantial financial scandal.  Adnan Abu-Odeh, a Jordanian businessman and politician, established the bank. The Petra Bank affair was a major financial crisis in Jordan’s history. The crisis included accusations of fiscal improprieties, deceit, and ineptitude in handling affairs. The bank’s involvement in dangerous lending practices, unapproved loans, and significant financial losses was exposed. Although the Petra Bank controversy largely centered on issues such as mismanagement, fraud, and improper transactions, it is crucial to acknowledge that earnings management is a separate notion. Earnings management sometimes entails the deliberate alteration of financial accounts, such as exaggerating revenues or postponing costs, in order to portray a more advantageous financial outlook (Azzoz & Khamees, 2016).

 

Researchers noted that there are several mechanisms of corporate governance that can impact the earnings management, and these include audit committee independence, board independence, culture of the company, a chief executive officer who is both chairman of the board as well as the chief executive officer, prevailing regulations, stock ownership, the existence of an independent external auditor (Li and Zaiats, 2017; Lo et al. 2017; Iatridis, 2018; Ben-Hassoun et al. 2018). Therefore, mechanism of corporate governance ensure that the reports are made based on the accounting standard, and it ensures the transparency of the disclosed information. These reports are audited by an external audits who examines the accuracy of the reports (Hutchinson et al., 2008; Putra, 2023).

 

The findings of the literature regarding the effect of corporate governance on earning management are still mixed and inconclusive as reported by several prior literature. A meta-analysis review indicated that the relationship between corporate governance and earning management is still mixed and there is a need for further theoretical development (Bansal, 2022). Positive effect of corporate governance on earning management was reported in previous studies (Mayasari et al., 2019: Sajjad et al., 2019; Asyiroh & Hartono, 2019; Adquisiciones et al., 2019; Yannizar et al., 2020; Ahmed et al., 2023). On the other hand, a negative effect between corporate governance and earnings management was also reported in several previous studies (Jaimuk et al., 2020; Abdelkarim & Zuriqi, 2020; Sriyono et al., 2022). Mixed and inconclusive findings were reported in previous studies as well  (Rahim et al., 2023; Ahmed et al., 2023; Jehadu & Hama, 2023).

 

Therefore, to solve the contradiction in this the relationship between corporate governance and earning management, a moderating variable might be able to explain the mixed findings. External auditor is a key variable that can to large extent improve the quality, accuracy, and integrity of reporting. However, few studies examined this variables as a moderator. Therefore, the purpose of this study is to examine the effect of corporate governance on earnings management. It also aims to examine the moderating role of external auditors. The study compares between Jordan and Malaysia to understand the differences and similarity in the conduct of corporate governance and earning management between two countries.

 

1.3       Problem Statement

 

Several scandals occurred in Jordan and Malaysia and these scandals were mainly related to issue of corporate governance. Jordanian and Malaysian industrial companies face challenges and problems in earnings management practices (Al-Zaqeba et al., 2022; Dakhlallh et al., 2020). Jordan has seen substantial financial difficulties, including noteworthy events such as the Petra Bank crisis in 1989 and the Shamayleh Gate incident in 2002. The latter incident resulted in Jordanian banks losing over $1 billion and triggered a major financial crisis.   As a result of this crisis, there were several corporate bankruptcies and a significant decrease in the value of the Jordanian Dinar compared to the US Dollar, dropping from USD 3.35 in 2006 to USD 1.41 in June 2008. Accounting software is widely used in Jordanian organizations and institutions, with a prevalence of 75% across all economic sectors. According to tax adviser Basil Abu Sultana, these software tools are often used for the purpose of manipulating accounting records. Imran Al-Talawi, the leader of the Auditors Association in Jordan, has verified that corporations engage in earnings management for diverse purposes, including tax avoidance and showcasing attractive financial data to entice investors. This manipulation often requires the cooperation of the accounting department inside companies.

 

In Malaysia also, one of the example of earning management is the Scomi Group Berhad in 2007. Scomi Group, a global service provider in the oil and gas sector, encountered accusations of financial improprieties. The company’s stock values plummeted after the publication of its financial accounts. The Securities Commission Malaysia (SC) has commenced an inquiry into Scomi Group’s financial reporting methods. The corporation was said to have used earnings manipulation in order to portray a more advantageous financial outlook. More precisely, Scomi Group was accused of engaging in financial misconduct by manipulating its financial statements. This was done by artificially increasing its reported revenues and deliberately downplaying its costs. This action was undertaken in order to fulfill market expectations, allure investors, and perhaps impact stock prices. The case brought attention to concerns about corporate governance, the openness of financial reporting, and the need for regulatory authorities to have efficient monitoring. The Securities Commission Malaysia implemented regulatory measures to tackle these challenges and bolster corporate governance standards in the Malaysian business landscape (Carlin et al., 2008).

 

Both Jordan and Malaysia have seen significant economic growth in recent decades, resulting in a highly competitive industrial environment. Companies may be motivated to participate in earnings management due to the need to satisfy financial expectations and exhibit constant growth. This can include the manipulation of financial statements in order to portray a more advantageous picture, which might possibly impact investors’ opinions and undermine market trust (Alhmood et al., 2020; Saleh et al., 2020). Furthermore, regulatory frameworks have a crucial impact in determining company conduct. The financial reporting rules in Jordan are established by the Jordan Securities Commission and Companies Law, but in Malaysia, corporate practices are governed by the Securities Commission and Companies Act. Notwithstanding regulatory efforts, there can exist deficiencies in enforcement or loopholes that enable corporations to participate in earnings management tactics. In addition, cultural influences also play a role in shaping the dynamics of financial reporting. Moreover, the degree of consciousness and proficiency within the field of auditing is crucial. The ability of external auditors to identify and avoid manipulative tactics in financial reporting is dependent on their expertise, impartiality, and adherence to established professional guidelines. The presence of any shortcomings in the auditing process can potentially exacerbate the ongoing issues related to earnings management (Almarayeh et al., 2022).

 

Moreover, the economic framework and market circumstances in each nation might impact the extent of profits manipulation. Industries that are particularly susceptible to economic volatility or have fierce competition may encounter increased pressure to effectively manage their revenues. For example, industries such as manufacturing in both Jordan and Malaysia may be especially vulnerable to such activities. The Sime Darby Berhad case is a good example in demonstrating the effect of earnings management practices. This relates to the huge establishment to have experienced massive deficiencies when an accusation was made against the top management of masking the truth in the firm’s annual report (Hamid et al. 2012). Johl, Subramaniam and Cooper (2013) shared a different famous instance involving the Transmile Group Berhad. As reported by Bernama, in the attempt of inducing for the purchase of the Transmile shares by the investors, officers and directors of the company had published a statement in its quarterly report which had given the wrong impression and had therefore been charged in court (Johl et al., 2013).

 

These actions reflect the undertakings of Malaysia’s earnings management where they indicate the actions taken by some firms in the attempt of hiding their true financial condition to attain the targets or goals of their desire (Johl et al., 2013). An accounting scandal involving the Transmile Group Berhad is another example where the fabrication of the revenue and profit were performed through earnings management. It can thus be portrayed that regulatory oversight and full disclosure failures had taken place in the Malaysian capital market, as well as the existence of financial statements that are unreliable and corporate governance that is weak (Mohamad et al. 2011). As in the case of Jordan, its industrial companies experienced several financial collapses, for example the Shamayleh Gate (Alhmood et al., 2020). This has resulted in Jordan being forced to consolidate the principles and foundations of corporate governance in promoting accountability, transparency and also the rule of law (Alzoubi, 2012). These cases have therefore demonstrated the importance of corporate governance mechanisms, for example, audit committee, ownership structure and board of directors in preventing the undertaking of earnings management in Jordanian and Malaysian industrial companies (Alhmood et al., 2020).

 

Studies which looked at corporate governance mechanisms and earnings management connection (audit committee, external audit factors, the structures of ownership, and board of directors) have found mixed results (Poretti, Schatt & Bruynseels, 2018). Abbadi, Hijazi & Al-Rahahleh (2016), and Abdulsamad et al. (2018) found that in Jordan and Malaysia, the reduction in earnings management level is more successful in companies with a higher percentage of board outside members. As a result of this, the credibility of financial reporting in these corporations was increased. On the other hand, Abdul Rahman and Ali (2006); Abed, Al-Attar and Suwaidan (2012) found that the quantity of directors from outside has had no effect in either decreasing or increasing earnings management in Jordanian and Malaysian companies. Apart from that, studies conducted by Hamdan, Sarea and Reyad, (2013); Alves, (2013); Bajra and Cadez, (2018) found that a large proportion of the audit committee and an independent audit committee would result in the escalation of earnings quality through the reduction of the level of earnings management practices. Studies conducted by Maroun and Solomon (2014) however, investigated on how the reputation of external auditors and change would be capable of curbing the undertakings of earnings management in the firms.

 

In addition to positive effects, the significant impact of mechanisms of corporate governance with reference to family ownership, size of the audit committee, board outsiders, audit committee independent, managerial ownership, size of the board, including the reputation of the external audit on the undertakings of earnings management are dealt with in some studies (Abbadi et al., 2016; Abdul Rahman and Ali, 2006; Abed, Al-Attar and Suwaidan, 2012; Kao and Chen, 2004; Alkdai and Hanefah, 2012; Madi et al. 2014; Hashim and Devi, 2008; Johari et al. 2008; Shukeri, Shin and Shaari, 2012). In contrast, the works of Alkdai and Hanefah, (2012), Yang and Krishnan (2005), Wan Mohammad, Wasiuzzaman, Morsali and Zaini, (2018); Saleh et al. (2007), Bukit and Iskandar, (2009), Wan et al. (2018), Toumeh and Yahya, (2017) indicate sufficient evidence for the negative influence that mechanisms of corporate governance have on the undertaking of earnings management. Kjærland et al. (2020) found that some of corporate governance has negative effect on earnings management such as (presence of employee representation on the board and the presence of an audit committee), while other of corporate governance mechanisms has a positive effect on earnings management practices such as (board independence and share ownership) in Nordic. In Jordan, Abed et al. (2012) examined the role of corporate governance (existence of independence members within the board of directors, the size of the board of directors, the role duality (CEO/chairman), the percentage of insider ownership) and they uses Jones models as proxy to earnings management. They found only the board size has significant impact in reducing earnings management practices in non-financial companies in Jordan. Alareeni (2018) found some board size has a negative impact on earnings management, while board independence and internal ownership are positively correlated with EM.

 

The mixed results in the literature could be due to methodological approaches, differences in conceptualization of the studies variables and differences in contextual settings of the studies. Therefore, this study focuses on different measures of corporate governance mechanisms that have a limited heighten in the literature. The absence of research on the function of external auditor in limiting the practice of earnings management is also highlighted by this study. In addition, few studies have compared both emerging economies to understand the similarity and differences and extracted the lesson learned from the practices of the two nations. Therefore, this study aims to develop a framework that can be used by decision makers in Jordan and Malaysia to improve the corporate governance and earning management understanding. The study also aims to highlight the role of external auditor in this process.

 

1.4       Research Questions

 

In order to look into the consequences that corporate governance mechanisms have on earnings management, the following questions have been formed:

  1. What is the effect of board of directors’ characteristic on earnings management of Jordanian and Malaysian industrial companies?
  2. What is the impact of audit committee characteristics on earnings management of Jordanian and Malaysian industrial companies?
  3. How do ownership structures influence earnings management of Jordanian and Malaysian industrial companies?
  4. Does external audit moderate the effect of corporate governance mechanisms on earnings management of Jordanian and Malaysian industrial companies?
  5. What are the similarities and differences in term of the effect of corporate governance mechanisms on earning management in Jordan and Malaysia?

 

1.5       Research Objectives

 

The Main Objective of The Study

 

The main objective of this study is to examine the effect of corporate governance mechanisms on earnings management of industrial companies listed in Amman Stock exchange and bursa Malaysia.

 

The Specific Objectives of the Study

The specific objectives of this study are:-

  1. To determine the influence of board of directors’ characteristics on earnings management of Jordanian and Malaysian industrial companies.
  2. To explain the impact of audit committee characteristics on earnings management of Jordanian and Malaysian industrial companies.
  3. To examine the influence of ownership structures on earnings management of Jordanian and Malaysian industrial companies.
  4. To examine the moderating role of external audit between corporate governance mechanisms and earnings management of Jordanian and Malaysian industrial companies.
  5. To compare the effect of corporate governance mechanisms on earnings management of Jordanian and Malaysian industrial companies.

 

1.6       Significance of the Study

 

This study is theoretically and practically is important. The study deals with a current and urgent issues such as earning management. Few studies have examined the association of corporate governance and earnings management in two countries and compared the practices in these countries. This study is significant because it compares the effect of these variables in Jordan and Malaysia. There are few studies that look at the relationship between corporate governance and earnings management (Shahwan, 2021). Researchers have previously assumed that their measurements represent corporate governance as a whole in the context of corporate governance. They extrapolated the outcomes of their assumptions without understanding that corporate governance is an interconnected system (World Bank, 2017) which led to the use of this technique (testing each corporate governance factor separately on earnings management).

 

This study is significant because it attempts to confirm the effect of corporate governance on earnings management. Findings of previous studies indicated that the effect is mixed and there is a need for more studies to solve the contradiction of the results. The study is also important because it examines the moderating role of external auditor. Few studies have done so. Further, the study is important because it employs four theories such as information asymmetry theory, agency theory, transaction cost theory, and stakeholder theory. Previous studies in the context of corporate governance is dominated by the agency theory.

 

The significance of this study is that it looks at the practice of earnings management by some Jordanian and Malaysian companies. This practice may be carried out by some corporate managers in attaining some of their personal goals, which results in a direct impact on the performance of these establishments. The framework of international accounting standards provides the flexibility for company management in selecting policies, procedures and alternative accounting methods. Company managers may therefore practice earnings management to achieve some personal purposes or objectives.

 

This study provides evidence about the effect of corporate governance on earnings management. In this regard, the results are important from various aspects. Since the earnings management mislead the shareholders about the real situation of the company. Corporate governance mechanisms seek in their role to protect shareholder’s interests. Therefore, the results is helpful for policy makers to take a new approach to the development of corporate governance instructions. Second, the results is helpful for stakeholders since improving governance instructions that enhance the quality of earnings and improving the quality of financial reports in general can help them build a comprehensive picture of the firm and then improve their decisions. Third, improving the quality of earnings reduces the problem of information asymmetry and thus increases the efficiency of companies in Jordan and Malaysia, which contributes to strengthening the role of the economies in both countries. In addition, since earnings management practices affect the growth, competitiveness and long-term continuity of companies, in this study by highlight on the updating of corporate governance rules, market value and competitiveness of institutions will have improved.

 

Hence, an important function is portrayed by mechanisms of corporate governance as the internal control system in the Jordanian and Malaysian industrial companies in detecting the level of earnings management practice and in reducing it to the lowest level, which will reflect the financial and the firms’ performance. Other than that, this study also determines the most effective motivations which result in the manipulation of earnings by company managers.

 

Thus, the significance of this study includes the following points:

  1. This study helps users of annual report (for example suppliers, investors and shareholders) to increase their knowledge about their firms and the financial performance, as well as convincing them about the reliability, credibility, and the disclosure level of the annual report for these companies.
  2. This study can be considered as a reference for academicians and researchers for future research in the same field. This is because, it is among the first studies on the comparison between Jordanian and Malaysian industrial companies in examining the similar consequences that internal mechanisms of corporate governance have on the financial accomplishment of these establishments.
  3. This study defines which of the four prime theories that is more suitable for the Jordanian and Malaysian industrial firms.

 

1.7       Scope of the Study

 

The scope of this study is from the period of 2013 to 2019. It utilizes firms from the Jordanian and Malaysian industrial sectors that are listed in the Amman stock exchange and the Bursa Malaysia. The study focuses on industrial sector because most of the previous studies were conducted on banking while few examined the industrial sector. In addition, the code of governance for industrial companies differ from the code of governance of other organizations. To comprehend the dissimilarities between the Jordanian and Malaysian economic environment as developing countries, the examination commences by talking about the setting where the firms function based on the prior literature. This is achieved through the comparison between the results of the prior literature and those of this research.

 

In understanding the differences and similarities between the approaches of these models in spotting earnings management, in understanding the definition of accruals utilised in other models and in facilitating the process of interpreting the empirical findings of this study, a critical analysis and comparison of the earnings management models employed in the literature are later conducted. The models include the Jones model (1991), the Modified Jones Model, Dechow et al. (1995), as well as Peasnell, Pope, and Young (2005)

 

The potential benefits in comprehending the characteristics of the Jordanian and Malaysian earnings management include that to the investors in deciding on the investment, to the auditors in performing the audit on Jordanian and Malaysian companies, to the government in preparing the draft of the legislation, and also to the regulators in setting the standards. This is because, as stated by Nawaiseh (2016), it is through these mechanisms that such understanding could eventually lead to more transparency and reliability in the published financial statements.

 

 

 

1.8       Summary

 

Chapter one as the introduction of the study begins with the discussion on the background of the study. It explains the problems of the research and discusses the mixed findings between corporate governance and earning management. The study aims to examine the effect of corporate governance and earning management among Jordanian and Malaysian industrial companies. The objectives of the study were discussed followed by the significance of the study, scope and the summary of the chapter. .

 

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