SENASTEK 2018

International Conference on Science, Technology and Humanity

EARNINGS MANAGEMENT STRATEGY SELECTION IN

FINANCIALLY DISTRESSED MANUFACTURING COMPANIES
IN INDONESIA

Putu Ery Setiawan, S.E., M.Com., Ak. (NIDN: 0007117905)

I Made Pande Dwiana Putra, SE.,MM.,Ak. (NIDN: 0020127702)
 BACKGROUNDS
MANAGEMENT BEHAVIOR Managers favor strategies that show instant
performance improvements during financial distress to avoid violations of debt
covenants, risk of losing employment and other motives. These among other
things propel managers to cover up what is really happening
EARNINGS MANAGEMENT CASES There are too many of such cases that betray
trusts among investors. Classic examples include Enron, WorldCom and Toshiba.
Local cases namely Kimia Farma, Lippo and Inovisi Infracom

INDONESIA’S RANKING IN INVESTOR PROTECTION Indonesia is one of countries

with low investor protection. In Asean, Indonesia ranks first in earnings
management practice
PRIOR RESEARCHES Researches in Indonesia mainly focused on accrual earnings
management while leaving real earnings management and classification shifting
strategies largely unexplored
 RESEARCH PROBLEMS

Which earnings management strategies are implemented during early stage of

financial distress?

Which earnings management strategies are implemented during advanced

stage of financial distress?

Which earnings management strategies are implemented during extreme stage

of financial distress?
 SPECIAL OBJECTIVES
BEHAVIORAL RESEARCH Management’s behavior during financial distress is an
interesting subject due to its subjective and opportunistic nature

STAGES OF FINANCIAL DISTRESS This research attempt to cover various stages of

financial distress to compare how earnings management strategy selections
differ in response to specific conditions faced during each stage

COMPREHENSIVE STRATEGIES This research follows a comprehensive approach to

earnings management, not limited to the “traditional” accrual earnings
management, but also includes real earnings management and classification
shifting
 RESEARCH’S URGENCY
TO RESEARCHERS By focusing solely on accruals strategy, certain biases or
incomplete understanding may develop. The selection of a certain strategy
often entails the selection of others. This research is expected to inspire similar
researches in the future

TO MANAGERS Management gains comprehensive perspective on all available

alternatives when dealing with financial distress, thus enhancing understanding
of general earnings management practices adopted by the industry

TO INVESTORS Investors improve comprehension on financial numbers presented

by the companies by acknowledging the underlying earnings management
strategies applied therein. This will minimize errors when making investment
decisions.
 FINANCIAL DISTRESS

DEFINITION A company is said to have experienced financial distress when it is

having difficulties in meeting debt payments or other obligations

ALTMAN’S Z-SCORE Financial distress’ most widely adopted proxy is Altman’s Z-

Score. Initially developed by Altman in1968 to predict bankruptcies
 EARNINGS MANAGEMENT
DEFINITION Generally the term earnings management is associated with
accruals earnings management. Managers are flexible in opting for various
alternatives of accounting treatments within the realms of generally accepted
standards. This flexibility is exploited by managers to distort earnings.
Approaches in accruals earnings management can take any of these four
forms: taking a bath, income minimization, income maximization dan income
smoothing

RESEARCH’S SCOPE Earnings management in this research is not limited to

accruals earnings management, but also includes real earnings management
dan classification shifting
 PRIOR RESEARCHES
ONLY ACCRUALS MANAGEMENT Prominent researches that discusses only
accruals earnings management in financially distressed firms are: Defond (1994),
Dichev (2002), Jaggi (2002), Rosner (2003), Callen et al. (2008)

ACCRUALS AND REAL MANAGEMENT Subsequently some researches start to

incorporate real earnings management strategy in addition to accruals earnings
management, such as: Lara et al. (2009), Zang (2012), Leggett et al. (2009),
Gunny (2010), Taylor (2010)

ACCRUALS, REAL MANAGEMENT AND CLASSIFICATION SHIFTING This category

includes researches from Fan et al. (2010) and Nagar (2016)
DATA AND SAMPLES
 METHODOLOGY
RESEARCH DESIGN Overall research design can be illustrated as follows:

Where stages of financial distress serve as independent variables (X) while earnings
management strategies serve as dependent ones (Y).
 METHODOLOGY
ACCRUALS EARNINGS MANAGEMENT (AM) as the dependent variable in the first
regression model is calculated from residual values of model developed by
Kothari et al., (2005):
 METHODOLOGY
REAL EARNINGS MANAGEMENT (RM) in this research is further divided into selling,
general and administrative expenses (SGA) and production level (PROD) as
dependent variables in regression model number two and three. The calculations
of these variables are adopted from Gunny (2010) :
 METHODOLOGY
CLASSIFICATION SHIFTING (CS) is the dependent variable of the last regression
model, calculated from core earnings values in a model by McVay (2006) :
 METODOLOGI
FINANCIAL DISTRESS STAGES which serve as independent variables are derived
from Altman’s Z-Score :

Financial distress is valued as 1 if Z-Score is less than 1,81 in year t-1, and
otherwise 0. these values are then transformed into stages of financial distress,
namely early stage (D1 and D2), advanced stage (D3 and D4) and extreme
stage (D5 or higher). D1 = 1 if firm is distressed in year t-1 while not distressed in
year t-2 to t-5, and otherwise 0, D2= 1 if firm is distressed in year t-1 dan t-2 while
not distressed in year t-3 to t-5, and otherwise 0, and so on
 METHODOLOGY
REGRESSION MODELS After all variables are calculated, their values are then
entered into these four regression models :

AM =α+ β1D1 + β2D2 + β3D3 + β4D4 + β5 D5+ ɛt

RD =α+ β1D1 + β2D2 + β3D3 + β4D4 + β5 D5+ ɛt
SGA =α+ β1D1 + β2D2 + β3D3 + β4D4 + β5 D5+ ɛt
PROD =α+ β1D1 + β2D2 + β3D3 + β4D4 + β5 D5+ ɛt
CS =α+ β1D1 + β2D2 + β3D3 + β4D4 + β5 D5+ ɛt

From p-values of each variable D1 to D5 in the above models, we can identify

earnings management strategies applied during each stage of financial distress
RESEARCH FLOW
 RESEARCH RESULTS
The resulting regression equations of models from Kothari (2005) for AM, Gunny
(2010) for SGA dan production (PROD), and McVay (2006) for CS in this research
are:
 RESEARCH RESULTS

Tests performed using abnormal levels of earnings management models as

dependent variables (Y) and stages of financial distress (D1, D2,D3, D4 and D5) as
independent variables (X), results in these regression equations:
 RESEARCH RESULTS
Detailed betas and p-values for each of those regression results are exhibited in
Table 3 below:
 CONCLUSION
Results of this study show that during early stage of financial distress companies opt
for real earnings management (i.e. lower production) and classification shifting to
reduce core earnings

While during advanced stage of financial distress the strategy of choice is real
earnings management through reduction in sales, general and administrative
expenditures

Lastly during final stage of financial distress firms opt for income-decreasing accrual
earnings management strategy