Abstract
The study aims to test investment inefficiency of fixed assets in mediating the relationship between free cash flow and earnings management and to test the controlling shareholders in moderating the relationship between free cash flow and fixed assets investment inefficiency. The research problem proposed in this study is whether the use of free cash flow for the investment inefficiency of fixed assets is able to ultimately improve the managerial performance. This research investigates new empirical evidence related to management earnings practices caused by free cash flow fixed assets investment inefficiency. The study was conducted on all the manufacturing firms listed on the Indonesia stock exchange from 2010 to 2015. The data used are secondary data in the form of the firms’ financial statements. Using purposive sampling, 314 units were analyzed from 69 manufacturing firms. The estimation of the path model was completed using Structural Equation Modeling (SEM) by WarpPLS program version 5.0. The results showed that free cash flow is positively related to earnings management. Fixed assets investment inefficiency is able to mediate the relationship between free cash flow and earnings management.
Highlights
Earnings management has been a negative trending topic in accounting literature, considered as a tool for managers to fulfill their personal interest
This study examines whether fixed assets investment inefficiency is able to mediate the relationship between free cash flow and earnings management
The theory of agency problem regarding the free cash flow states that a conflict of interest between Chung et al (2005) argue that the firms’ free cash the insider and the outsider in terms of minority sharehold- cover failed projects
Summary
Earnings management has been a negative trending topic in accounting literature, considered as a tool for managers to fulfill their personal interest. A number of studies argue that earnings management can provide benefits due to potentially increasing the earnings information value Managers can use their own discretion in communicating financial information to shareholders and public (Demerjian et al, 2016; Holthausen, 1990; Jiraporn et al, 2008; Subramanyam, 1996). The managers are likely to have the motivation to report profits in an effort to meet the expectations of shareholders or investors on the future cash flow It can reduce the potential for conflicts, known as agency problem, between management and the various parties, including shareholders. This study analyzes the moderating effect of the controlling shareholders in the relationship between free cash flow and fixed assets investment inefficiency
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