THE EFFECT OF EARNINGS MANAGEMENT ON THE VALUE RELEVANCE OF EARNINGS AND BOOK VALUE

Abstract

Earnings and book value are commonly used as the basis for firm valuation. However, the reliability of earnings which affected by earnings management may affect accounting informations’ relevance in determining firm value. This thesis investigates the link between earnings management and firm valuation by assessing the impact of earnings management on the value-relevance of earnings and book value. This study estimates discretionary accruals using the Modified Jones model with ROA (Kothari, 2005) as earning management proxy. The population in this research is manufacturing companies listed on Indonesia Stock Exchange 2009-2011 period. Samples are selected using Purposive Sampling Method. From samples selection, 108 indicated earnings management firms (higghest discretionary accruals) and 108 non-indicated earnings management firms (lowest discretionary accruals) are obtained. Hypothesis 1 test result shows that earnings and book value affect stock price. It proves that earnings and book value are value relevant. Hypothesis 2 test result shows that earnings management reduces the value-relevance of earnings and book value. It is due to the decrease of accounting information reliability. This link between the integrity of accounting information and its usefulness to market participants supports the need for ongoing regulatory activity and management policy as well as educational program to improve the integrity of financial reporting process.

Keyword: earnings management, discretionary accrual, value-relevance, earnings, book value, stock price