Three essays on political connections, financial reporting, and auditing : evidence from Indonesian listed companies : a thesis presented in partial fulfilment of the requirements for the degree of Doctor of Philosophy in Accountancy at Massey University, Albany, New Zealand
This research examines the association between political connections and related party transactions (RPTs). This study also investigates whether politically-connected firms use RPTs to tunnel resources and mask “true” operating performance by managing earnings. This study is motivated by conflicting views on whether political connections are beneficial or detrimental to stakeholder interests. In addition, this research investigates how political connections, in concert with RPTs, determine auditor choice in Indonesia. This auditor choice aspect of the study is motivated by the conflicting views and inconclusive findings on whether politically-connected firms will appoint reputable auditors, i.e., the Big 4 audit firms, or non-Big 4 auditors. Essay one examines the relationship between political connections and RPTs and investigates whether firms with political connections engage more or less in RPTs. It hypothesizes that politically connected firms conduct more value-destroying RPTs compared to non-politically connected firms, because they have more power and opportunities gained from their connections. The findings of essay one reveal that politically connected firms conduct more RPTs compared to non-politically connected firms. In terms of economic significance, the reported coefficient suggests that, compared to non-connected firms, politically connected firms carry out 43% more RPTs. However, the regression results show that the significant influence of political connections applies only to RPTLOAN (RPT loans and guarantees). In order to capture the richness in political dynamism in Indonesia, a finer classification of political connections is utilized where connected firms can be classified further into government, military, and Suharto connections. Using this approach, the study reveals that only the coefficient of GCON (government connection) is positive and significant, suggesting that listed firms having political connections with the Government will conduct more RPTLOANs. The insignificant influence of Suharto and military connections occurs because, after Suharto‟s resignation, firms associated with Suharto and military personnel had difficulties in establishing a connection with the new government, and experienced loss of government contracts, distributorships, and brokerage monopolies.
Essay two investigates whether politically connected firms use RPTs to tunnel resources, and to mask “true” operating performance by managing earnings. This essay argues that politically connected firms have incentives to conduct more tunnelling compared to non-politically connected firms, due to the costs of establishment and maintenance of political connections, the opportunity to seize the benefits brought by political connections, and fewer disciplinary constraints from laws and regulations. Such tunnelling activities cause the economic performance of politically connected firms to deteriorate and, as a result, they need to be concealed by conducting income-increasing earnings management. Essay two provides empirical evidence that politically connected firms use RPTs to tunnel resources, and to engage in income-increasing earnings management designed to mask tunnelling activities. Essay three investigates how political connections determine auditor choice in Indonesia. This essay proposes that, because of tunnelling incentives, firms having political connections with the government might appoint non-big four auditors in order to allow them to have less transparent financial statements and to obfuscate their tunnelling activities. On the other hand, following the collapse of the Suharto regime, privileges and benefits enjoyed by firms having connections with Suharto and the military have gone, so that they have less incentive to engage in tunnelling and financial report manipulation in order to obfuscate such tunnelling. Therefore, essay three proposes that firms having connections with Suharto and the military are more likely to hire the Big 4 auditors. The results of essay three document that politically connected firms in Indonesia tend to choose non-Big 4 auditors. When a finer classification of political connections is used the regression results show that firms having connections with the government are more inclined to choose non-Big 4 auditors, whereas those with connections to Suharto have the option to appoint Big 4 auditors.Further, essay three also proposes that since RPTs involving loans allow politically connected firms to siphon resources, there is an incentive for those firms to manipulate financial reports in order to obfuscate “true” economic performance. Thus, politically connected firms with RPT loans are more likely to choose non-Big 4 auditors. Essay three documents that RPTs have a significant influence on the appointment of auditors of politically connected firms. The tendency to appoint non-Big 4 auditors increases when firms have political affiliations with the government and carry out RPTs.
political connections, politically connected firms,
related party transactions, tunnelling, earning management,
auditor choice, Indonesia