Earnings Management and Fraudulent Financial Reporting: The Malaysian Story

Earnings management research has a long and rich history. The agency conflict, incentives, rationalization, opportunity plus having the capability among the managers to manipulate the financial statements lead them to commit fraud. The loopholes in the standards or the deviation from real operational activities promote this situation to prolong. In relation to this issue, this study examines the earnings management behavior among fraud firms in Malaysia. Further, this study examines the relationship between accruals earnings management as a proxy variable for discretionary accruals and real earnings management as the proxy variable for discretionary cash flow. Sample of 57 alleged fraud firms was selected based on the fraudulent financial reporting offences announced in Bursa Malaysia website. The sample data are collected from public firms which committed fraud from 2001 to 2013. This study found a significant negative relationship between accruals earnings management and real earnings management among the fraud firms in Malaysia suggesting that these firms aggressively manage earnings downwards or upwards essentially to avoid regulators scrutiny apart from aiming to achieve personal incentives. The study significantly finds evidence that fraud firms manage earnings on a sequential basis between accruals earnings management and real earnings management prior to fraud year. The findings indicate that firms opt for real earnings management and make full use of its distinguished features of not easily traceable to continue managing earnings immediately subsequent to fraud year. This study may assist regulators, auditors, and policymakers to curb earnings management patterns that have high likelihood of becoming part of fraud antecedent.