Figure Ilustration AIThe findings matter for investors, auditors, regulators, and business leaders because financial statements remain the primary source of information used to evaluate company performance and make investment decisions. Reliable financial reporting strengthens public trust in capital markets, while manipulated earnings can mislead investors and distort economic decision-making.
Why Earnings Management Matters
Financial reports are designed to present a company’s financial position accurately and transparently. However, companies sometimes engage in earnings management, a practice in which managers adjust accounting policies or operational decisions to influence reported profits.
This behavior is often driven by pressure to meet profit targets, maintain stock market confidence, or secure performance-based bonuses. In some cases, companies attempt to present smoother or more stable earnings to make their financial performance appear less risky to investors and creditors.
Several high-profile financial reporting controversies have brought attention to this issue. For example, disputes surrounding financial statement reporting in large companies have demonstrated how differences in revenue recognition or accounting treatment can significantly change the appearance of corporate profitability.
Because of these concerns, researchers and policymakers increasingly focus on identifying the factors that encourage—or discourage—earnings manipulation in corporate reporting.
Research Focus and Methodology
Julia Kristy and Widyawati Lekok designed their study to examine which corporate characteristics influence earnings management among Indonesian manufacturing firms. The researchers analyzed eight independent variables:
- Company size
- Company age
- Profitability
- Leverage (debt level)
- Size of the board of commissioners
- Tax planning
- Audit quality
- Managerial ownership
The study used financial data from manufacturing companies listed on the Indonesia Stock Exchange (IDX) between 2021 and 2024. After applying selection criteria, the researchers obtained 243 observations from 81 companies. The data were analyzed using multiple regression analysis, allowing the researchers to measure how each factor influences earnings management while controlling for other variables. Earnings management itself was measured using the Modified Jones Model, a widely used method that estimates discretionary accruals to detect potential manipulation in financial statements.
Key Findings
The results reveal that only two factors significantly influence earnings management among the firms studied: leverage and audit quality.
1. Leverage significantly affects earnings management
Companies with higher debt levels tend to behave more cautiously in managing reported earnings. Statistical results show that leverage has a significant negative relationship with earnings management, meaning firms with higher debt ratios are less likely to manipulate profits. The researchers explain that companies with substantial debt face stricter monitoring from creditors and lenders. This external pressure encourages firms to maintain credible financial reports and avoid aggressive accounting practices.
2. Audit quality reduces earnings manipulation
- Audit quality also plays a significant role. Companies audited by higher-quality auditors tend to show lower levels of earnings management because stronger oversight makes manipulation more difficult.
- High-quality auditors—often associated with well-established accounting firms—have stronger expertise and stricter auditing procedures, enabling them to detect irregularities in financial reporting.
3. Several factors show no significant impact
Interestingly, the study found that several variables commonly assumed to affect earnings management did not show significant influence:
- Company size
- Company age
- Profitability
- Board of commissioners size
- Tax planning
- Managerial ownership
These findings suggest that governance structures and ownership patterns alone may not be sufficient to prevent earnings manipulation without effective external oversight.
Implications for Business and Policy
The research provides important lessons for multiple stakeholders in Indonesia’s financial ecosystem.
- For investors, the findings highlight the importance of paying attention to a company’s leverage level and the reputation of its external auditor when assessing financial statement reliability.
- For regulators and policymakers, the study reinforces the role of strong auditing standards in maintaining transparency in public companies. Strengthening audit supervision could help reduce financial reporting manipulation across industries.
- For corporate managers, the results emphasize the value of maintaining credible financial reporting practices. Companies that engage reputable auditors and maintain responsible debt management are more likely to build long-term trust with investors and creditors.
According to the authors, external monitoring—particularly from creditors and auditors—remains one of the most effective mechanisms for reducing earnings manipulation.
As Widyawati Lekok of Trisakti School of Management notes through the study’s analysis, companies audited by high-quality auditors generally display lower levels of earnings management due to stricter supervision and stronger detection capabilities.
Study Limitations and Future Research
The authors acknowledge several limitations in the research.
The study focuses only on manufacturing companies and covers a three-year observation period, which may limit the generalization of results to other sectors. In addition, the eight variables examined explain only a portion of the variation in earnings management behavior.
Future research could expand the observation period, include companies from other industries, and examine additional variables such as financial distress, ownership concentration, or corporate governance practices.
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