UNIVERSITY OF ECONOMICS AND LAW FACULTY OF ACCOUNTING AND AUDITING GRADUATION THESIS THE IMPACT OF CORPORATE GOVERNANCE ON EARNINGS MANAGEMENT OF VIETNAM LISTED COMPANIES SUPERVISOR : MSC. NGUYEN THI PHUONG LOAN CANDIDATE : NGUYEN NGO PHUC THINH STUDENT ID : K134091131 CLASS : K13409CLC HCMC, 5/2017 i ACKNOWLEDGEMENT I would like to express my special appreciation to my current advisor MSc. Nguyen Thi Phuong Loan. You have been a tremendous mentor for me.
I would like to thank you for supporting and encouraging my research and for allowing me to develop as a scientific research. Your advices on my research and the discussions have been priceless for me and I am grateful for everything I would also like to thank members in previous scientific research group for brilliant comments and suggestions in previous researches, which assist me to develop current research. I would especially like to thank instructors and lectures in Center for Economics and Finance of the University of Economics and Law. All of you have been there to support me when I collected available data from Thomson Reuter DataStream for my research.
ii ABSTRACT This research measures the discretionary accruals from the Modified Jones model (1995) and investigates the impact of corporate governance on the earnings management of listed firms in Ho Chi Minh City Vietnam. The sample data had been collected from Thomson Reuter, which includes 196 listed firms from 2012 to 2016 excluding particular industries as finance, insurance and real estate. I hypothesize 3 proxies of the corporate governance. In which, board size and board independence are both negatively associated with earnings management.
This also hypothesize that CEO duality is positively associated with earnings management The finding indicates same as 2 hypotheses that board size and board independence are both negatively associated with earnings management. However, this found there are no relation between CEO duality and earnings management Keywords: Earnings management, corporate governance, board size, CEO duality and board independence. iii CONTENTS INTRODUCTION. BACKGROUND OF RESEARCH.
SUBJECT AND SCOPE OF RESEARCH. STRUCTURE OF RESEARCH. 4 CHAPTER 1: THEORETICAL FOUNDATIONS AND RESEARCH HYPOTHESES .1 TERMINOLOGY AND DEFINITIONS .1 The agency theory .2 Transaction cost theory. 13 CONCLUSION FOR CHAPTER 1.
16 CHAPTER 2 RESEARCH METHODOLOGY .1 SAMPLE SELECTION AND DATA .1 Measurement of Earnings Management .2 Estimation models and regression formula. 23 CONCLUSION FOR CHAPTER 2. 25 CHAPTER 3 RESEARCH RESULTS .1 ESTIMATING REGRESSION MODEL .1 Panel data model selection .3 Model Regression Analysis .2 Identification of regression model defects .1 Test of Autocorrelation .2 Test of Collinearity. 31 CONCLUSION FOR CHAPTER 3.
33 CHAPTER 4 LIMITATIONS AND RECOMMENDATIONS .1 Limitations of the research .1 Recommendation proposed for the management agencies .2 Recommendation proposed for audit companies .3 Recommendation proposed for listed companies. 35 v LIST OF TABLE Table 1.1: Summary of theoretical foundations Table 1.2: Empirical studies for association between CEO duality and earnings management Table 1.3: Empirical studies for association between Board Size and earnings management Table 2.1: Industries Classification Table 2.2: Summary of variables Table 3.1: Redundant Fixed Effects Test Table 3.2: Hausman Test Table 3.3: Descriptive Statistics for regression model Table 3.4: The result of model regression analysis Table 3.5: The Correlation Probability of variables vi LIST OF ABBREVIATION GICS: Global Industry Classification Standard HOSE: Ho Chi Minh Stock Exchange FEM: Fixed Effects Model REM: Random Effects Model 1 INTRODUCTION 1. BACKGROUND OF RESEARCH Earning management is a typical issue of listed firms before and after auditing. Following Fit to Bust: How Great Companies Fail, WorldCom is one of the largest telecommunication in the United Stated with more than $30 billion annually revenue and $104 billion of assets.
Suddenly, WorldCom became bankrupt in 2002 with inflated assets by $11 billion, leading to 30,000 lost jobs and $180 billion in losses for investors. The responsibility of the CEO of WorldCom Bernie Ebbers is significant in this case. Bernie Ebbers capitalizing inflated revenues with fake accounting entries and the internal auditing department uncovered $3.8 billion of fraud. As a result, he was sentenced to 25 years for fraud, conspiracy and filing false documents with regulators.
The bankruptcy that followed led to massive losses not only for investors but also for retailers and employees. This raise more concern about the role of corporate governance on business performance since the case of WorldCom, which is one of the largest communication enterprise in the world. In Vietnam, Vinashin have major of corporation’s capital is borrowing from credit institutions, bonds from both domestic and foreign sources according Tuoi Tre newspaper in 2005. While the borrowing accounted for over 72 trillion VND in 2010, VINASHIN still maintained a relaxing management procedure, which leaded to violate of regulation of mobilization capital process.
Furthermore, VINASHIN had violated numerous contracts leading to cancel many shipbuilding contracts and paid penalty up to 1,000 billion VND. Following the investigation by the security agency, it showed that the State budget has suffered losses of nearly 907 billion from VINASHIN case. Moreover, its consequences are not only economic but also political issue. In particular, VINASHIN have 100% capital from government resulting in the rumour that the government cannot strictly control their investments.
On the other hand, other listed firms were also affected by this event. In which, the interest of borrowing could be increase as the market index went down. 2 In 2015, the information from Vietstock showed that among listed companies that disclosed their 2014 financial statements, 196 companies have differences after issuing audited reports. Some listed companies are turning profit into loss or vice versa.
In Ho Chi Minh, HACISCO turned the loss of 39 billion VND in 2014 to profit of 4.5 billion VND after the audited report. The reason for this adjustment is due to the retrospective adjustment of provisions relating to administrative cost, which accounted for 42 billion VND. In contrast, NTACO turn from 187 million VND profit after tax to loss of 14. The managers of NTACO explained vaguely that revenue of operation and financial activities increased, however the costs remained high, leading to the loss, without explaining the difference between before and after audited.
While the seafood industry had reported their efficiency and effectiveness in business operation in 2014, Vietnam Seafood Japan Corporation reported 43.5 billion VND losses after auditing. The manager of Vietnam Seafood Japan Corporation claimed the difference is caused by provision for inventory and revaluation the foreign currency exchange rate. This mislead the investor’s perception and make investor confuse about earnings management of listed firm. They may suffer financial loss when the market lose expectation on their invested firms.
Many empirical studies have been researched in developed countries to indicate the relation among earnings management and corporate governance. However, this topic in developing countries like Vietnam is still limited. Therefore, the research of “The Impact of Corporate Governance on Earnings Management of Vietnam Listed Companies” reflects the current earnings management is affected by various factors in which includes the corporate governance. RESEARCH OBJECTIVES The objectives of research are investigating and analyzing the impact of corporate governance’s characteristics on earnings management of listed companies on Ho Chi Minh City.
To achieve the objectives, the research will measures earnings management, as well as, three characteristics of corporate governance (CEO duality, board size and board 3 independence). Finally, based on the result, the research will propose some recommendations for user of financial statements of companies listed on the stock market of Vietnam, together with, the management of those companies. SUBJECT AND SCOPE OF RESEARCH Research subject: Listed companies on Ho Chi Minh City Stock Exchange (HOSE), in detail, the annual reports of those companies from 2012 to 2016. Research scope: + Space: analyzing corporate governance of 196 listed firms on HOSE from various industries except banking, insurance, real estate and investment fund because these industries have different accounting treatment and characteristics of operations.
+ Time: the period from 2012 to 2016. RESEARCH METHODOLOGY The research of earnings management is quantitative approach and estimates panel data model with Fixed Effects Model (FEM). This is explained by various reasons like the quantitative approach is more reliable and objective and methodology is less subjective. Furthermore, this approach can show the relationships of cause and effect between variables.
The research use the data which are aggregated statistically from Thomson Reuters' DataStream and Eikon of five years from 2012 to 2016 for 196 listed companies on Ho Chi Minh City Stock Exchange (HOSE). The listed companies come from various industries except banking, insurance, real estate and investment fund because these industries have different accounting treatment and characteristics of operation. STRUCTURE OF RESEARCH The research focuses on issue to evaluate the impact of corporate governance on earnings management in Ho Chi Minh City (HOSE)13 in Vietnam. In short, the research can be divided into the following main parts: Chapter 1: Theoretical Foundations and Research Hypotheses The research describes the literature review and hypothesis development for defining the composition of corporate governance, earnings management and the relationship between earnings management and corporate governance through empirical studies.
Chapter 2: Research Methodology The research measures earnings management proxied by total accruals, which includes discretionary accruals and non-discretionary accruals through the modified Jones model (1995). Afterward, the impact of corporate governance on Earnings management is demonstrated with the regression model. Chapter 3: Research Results The research evaluates econometric tools in E-views 8 to select appropriate model among Pooled OLS (Ordinary Least Squares), FEM (Fixed Effects Model) and REM (Random Effects Model) for regression analysis. Besides, the factor analyses also are demonstrated detail with Autocorrelation test and Collinearity for panel data.
Chapter 4: Limitations and Recommendations The research defines some limitations containing after evaluating the impact corporate governance on earnings management and propose recommendations for following researches. 5 CHAPTER 1 THEORETICAL FOUNDATIONS AND RESEARCH HYPOTHESES 1.1 TERMINOLOGY AND DEFINITIONS 1.1 Earnings Management Earnings management has been conceptualized in many ways. According to Schipper, the earnings management could be defined as “a purposeful intervention in the external financial reporting process, with the intent of obtaining some private gain” (Schipper, 1989). In other perspective, Healy and Wahlen stated that “earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of a company or to influence contractual outcomes that depend on reported accounting numbers” (Healy and Wahlen, 1999).
Following this point of view, Akers, Giacomino, and Bellovary defined earnings management as “attempts by management to influence or manipulate reported earnings by using specific accounting methods (or changing methods), recognizing one-time non-recurring items, deferring or accelerating expense or revenue transactions, or using other methods designed to influence short-term earnings” (Akers, Giacomino, and Bellovary, 2007). Based on these definitions, earnings management can be specified as the selection of accounting policies and treatments so that some particular managers’ objectives can be achieved. However, there should be a distinction between fraud and earnings management. Fraud is defined as “intentional act or omission designed to deceive others, resulting in the victim suffering a loss and/or the perpetrator achieving a gain” (Association of Certified Fraud Examiners).
In other words, fraud is the illegal actions that violate accounting standards. In the other hand, earnings management is the choices of managerial officers between accounting methods, which enable managers to prepare true and fair financial statements. Therefore, to some extent, earnings management is still acceptable within the bounds of accounting standards. 6 The direction of earnings management can be in two directions: income-increasing earnings management and income-decreasing earnings management, which are based on management purposes.
Following Healy (1985), management’s judgment for managing reported earnings increasing or decreasing depends on bonus conditions and the level of pre-managed earnings to maximize bonuses. In contrast, Nelson, Elliot and Tarpley (2003) claimed the manager tends to decrease earnings management to maximise compensation in the future.