The effect of corporate governance and firm-specific characteristics on the incidence of financial restatement
| Date | 06 August 2020 |
| DOI | https://doi.org/10.1108/JFC-06-2020-0103 |
| Published date | 06 August 2020 |
| Pages | 244-267 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial crime |
| Author | Suhaily Hasnan,Mardhiahtul Huda Mohd Razali,Alfiatul Rohmah Mohamed Hussain |
The effect of corporate
governance and firm-specific
characteristics on the incidence of
financial restatement
Suhaily Hasnan,Mardhiahtul Huda Mohd Razali and
Alfiatul Rohmah Mohamed Hussain
Faculty of Accountancy, Universiti Teknologi MARA (UiTM),
Shah Alam, Malaysia
Abstract
Purpose –This paper aims to examine the effectsof corporate governance and firm-specific characteristics
on the incidenceof financialrestatement among Malaysian public listed firms.
Design/methodology/approach –The elements of corporate governance consist of board size, board
independence, multiple directorships, audit committee expertise, external audit quality and executive
compensation. Meanwhile, the firm-specific characteristics consist of firm age, firm performance, firm
leverage and firm liquidity.The agency theory has been used to guide the study. This study used a matched-
pair sample that consisted of a sample of 49 restatement firms and 98 non-restatement firms between the
years 2011 and 2016. Univariate (t-test and Pearson correlation) and multivariate (logistic regression)
statisticaltechniques were used to test the hypotheses.
Findings –The results show that there is a negative and significant relationship between
executive compensationand firm performance, and the incidence of financial restatement.In addition, there is
a positive and significant relationship between firm leverage and the incidence of financial restatement.
However, the othercorporate governance and firm-specific characteristicvariables included in the study were
found to be insignificant with the incidenceof financial restatement. This paper provides evidence that some
form of corporate governance mechanisms and firm-specific characteristics, particularly executive
compensation, firm performance and firm leverage, may influence the direction and magnitude of the
incidence of financial restatement. The findings indicate that optimal executive incentives may align
management interestswith those of shareholders. In addition, greater performanceand lower leverage levels
minimise firms’financial pressure and debt covenant violation risk, which may reduce the management
tendency to misstate the financial statement, and consequently, minimise the likelihood of financial
restatement.
Originality/value –The main value of this paper is the effectof corporate governance and firm-specific
characteristics on the likelihood of financial restatement in Malaysia. The findings of this study provide
useful insights for regulators to improve and reconsider the current regulations on corporate governance
mechanisms.
Keywords Corporate governance, Firm characteristics, Financial restatements, Malaysia
Paper type Research paper
Funding: ARI HICoE Grant (600-IRMI/ARI 5/3(029/2019)
The authors would like to express their gratitude to the Accounting Research Institute, Universiti
Teknologi MARA and Ministry of Education of Malaysia for funding the research project through
the ARI HICoE Grant (600-IRMI/ARI 5/3(029/2019). Our appreciation also goes to the Faculty of
Accountancy, Universiti Teknologi MARA for facilitating this research project.
JFC
28,1
244
Journalof Financial Crime
Vol.28 No. 1, 2021
pp. 244-267
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-06-2020-0103
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
Introduction
Afinancial statement is a report that summarises a firm’s operations, activities, financial
position and business performance. Fundamentally, the financial statement is the main
source of information that various parties in the financial market use to analyse firms’
activities (Anderson and Yohn, 2002;Kim and Koo, 2014) and make decisions. Because of
that, a fraudulent or erroneous financial statement can cause a wrongful judgment or
decision to be made. As a restatement indicates that the preceding financial information
reported contains an error and is inaccurate, the previous decisions made by users of the
financial statementmay also be affected. Indirectly, it can affect the efficiencyof the market.
To overcome such problems, it is importantfor a company to produce high-quality financial
statements (Herathand Albarqi, 2017).
According to the Companies Act 2016 (Act 777), the preparation of financial statements
should follow the accounting standards. However, the Generally Accepted Accounting
Principles (GAAP) offer flexibility to companies with several accounting policy options,
which then creates the opportunityfor them to window-dress their financial statements,and,
in turn, increase the incidence of restatement at a later period (Albring et al., 2013;Qasem
et al.,2017). According to Schroeder (2001), the Securities and ExchangeCommission in the
USA mentioned that the most noticeable indicator for inappropriate accounting is through
restatement. A restatement is also an obvious signal that a company’s prior financial
statements were unreliable and of relatively lower quality (Anderson and Yohn, 2002).
Impliedly, the occurrence of financial restatement indicates a serious failure of financial
reporting, and evidently, can significantlyaffect many organisations, institutions, investors,
markets and regulators(Chi and Sun, 2014).
According to Rasyid and Ardana (2014), corporate governance implementation can help
to minimise the incidence of financial restatement. Hence, it is necessary for all companies
that are publicly listed to implement the concept of corporate governance (Rasyid and
Ardana, 2014). Corporate governance provides a control mechanism framework that can
help companies to achieve their goals while preventing undesirable conflicts (Securities
Commission Malaysia, 2017). However, despite all the corporate governance mechanisms
introduced by the regulators, the ability of companies to manipulate financial statements
still persists. Ultimately, such manipulationleads to the occurrence of financial restatement.
This has been proven through the discoveryand announcement of several Malaysian cases,
such as the CSM Corporation Berhad, OilCorp Berhadand Aktif Lifestyle Berhad (Abdullah
et al.,2010). These companies were required to amend and reissue their financial statements
after they were knownto be involved in financial statement manipulation.
Apart from corporate governance practices, companies vary in many ways. As such, it is
worth considering how such differences among companies may influence the incidence of
financial restatement. The study by Rezaei and Mahmoudi (2013) suggested that firm size and
firm losses in the year before the restatement have a relationship with financial restatement,
while other scholars suggested that there are associations between company characteristics and
earnings management (Waweru and Riro, 2013;Swai, 2016;Alareeni, 2018). Thus, it is believed
that firm-specific characteristicsmay also contribute to the occurrence of financial restatement.
Conceptualisation
Financial restatement
Afinancial restatement is defined as the adjustment of the financial statement because of
the failure to comply with the GAAP requirements (Abdullahet al.,2010;Wan Mohammad
et al., 2018). Basically, the occurrence of financial restatement happens when financial
statements are found to contain a material misstatement.A misstatement is a manipulation
Incidence of
financial
restatement
245
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