Government-Linked Investment Companies and Real Earnings Management: Malaysian Evidence

Abstract

This study examines the association between government-linked investment companies’ (GLICs’) shareholdings and real earnings management activities in Malaysia. Consistent with prior research, this study uses three proxies to measure real earnings management; abnormal cash flow from operations (RCFO), abnormal production costs (RPC), and abnormal discretionary expenses (RDE). This study segregates GLICs’ shareholdings into two categories; Federal Government Pension Investment Funds (FGPIF) and other GLICs (OFGLIC). Using a sample of 213 firm-year observations of Malaysian government-linked companies from 2010 to 2015, this study finds that FGPIF is a more effective monitoring mechanism than OFGLIC in limiting real earnings management. The findings also show that there is a significant and negative relationship between Employee Provident Fund (EPF), Khazanah Nasional Berhad (Khazanah), Permodalan Nasional Berhad (PNB) and RCFO and RPC. The evidence suggests that these three are the most effective government institutional investors in promoting corporate governance, which in turn limit real earning management activities in Malaysia. In general, the findings support the incentive alignment hypothesis, which argues that companies with government intervention are normally better governed.